The Tell: Here’s what stock-market investors may have wrong about ESG as the great rotation unfolds, says BofA


Funds focused on environment, social and governance criteria may be better off than many think when it comes to benefiting from the rotation into value stocks, according to a BofA Global Research report.

“One critique of ESG investing is that it tends to favor growth stocks at the expense of value-oriented sectors,” Savita Subramanian, an equity and quant strategist at Bank of America, said in a research note dated April 1. “But our analysis of US-domiciled ESG fund holdings presents a different picture.”

BofA found that ESG funds are overweight industrials, materials and real estate relative to the S&P 500 index
“with significantly more exposure to these pro-cyclical sectors than mutual funds broadly,” according to the note. ESG funds have meanwhile avoided growth-oriented, communication services stocks, Bank of America found.

Long-only fund investment managers generally have been moving into value-oriented sectors, boosting bets on financial and energy companies in recent months while trimming weightings to growth-oriented, technology and communication services sectors, according to BofA. Value stocks trounced their growth counterpart in the first three months of 2021 after suffering a decade of ineptitude.

For example, the Russell 1000 Value

fund rose nearly 12% in the first quarter, compared with a 2.4% gain for the Russell 1000 Growth index
FactSet data show.

ESG funds may be poised to benefit from a further rotation into value, as they remain “significantly underweight” energy and utilities even after increasing their exposure to these areas in recent months, the bank’s research notes shows.

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Clean-energy valuations have meanwhile soared over the past few years, with renewables surging on investor enthusiasm for the future of the industry, according to JPMorgan Chase & Co

Renewable-focused ETFs have traded lower so far in 2021 but have enjoyed powerful gains over the past 12 months, with the iShares Global Clean Energy ETF

up over 160% on the year and the Invesco Solar ETF

boasting a nearly 270% return over the same period.

“Towards the end of last year, the sector just went bananas,” Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset Management, said Friday in a phone interview with MarketWatch. “There’s a lot of speculation right now that the United States is on the brink of a catch-up” with Europe in terms of ESG, he said.

Renewable stocks in areas such as electric vehicles, solar, hydrogen and batteries have jumped since 2019, according to a J.P. Morgan Asset Management note from Cembalest on April 1.

“The last three years have really seen an enormous push by asset managers to bring more renewable energy companies onto their platforms and to give people more access,” he told MarketWatch Friday. Cembalest added “the SPAC market has expanded the opportunity for those companies to go public,” with a “disproportionate share of renewables” having gone public through mergers with special-purpose acquisition companies.

“The energy sector, maybe even more than tech, attracts futurists,” he said. “It’s a sector that attracts a lot of people who visualize massive secular changes taking place in short periods of time.”

J.P. Morgan Asset Management believes renewable stocks remain expensive even after the industry’s selloff in January, according to Cembalest. “I’m tempted to wait a little more,” he said on diving back into renewables. “There’s some interesting opportunities here, but you really have to let the froth subside.”

While President Joe Biden’s infrastructure plan stands to benefit from renewable energy, Cembalest expects some trade-offs will be made before a final bill is passed in Congress. Many investors began pricing in the impact of an infrastructure plan under the new administration as early as last year, but it is still too soon to make assumptions, he said.

Meanwhile, the U.S. jobs report Friday signaled the economy may be on track for a rapid expansion.

The U.S. added 916,000 new jobs in March, as restaurants and other businesses hired the most workers in seven months. The Labor Department said Friday that official unemployment declined to 6%, from 6.2%, though economists estimate true unemployment stands at more than 9% after accounting for Americans who have left the labor force after losing their jobs last year.

Read: U.S. gains 916,000 new jobs in March and signals strengthening economy

A strengthening economy generally bodes well for value stocks, according to Cembalest.

BofA strategists believe long-only fund managers may continue to rotate into value as “their tilts to industrials, financials, energy and materials sectors remain below historic averages.” The recent rise in traditional oil and gas stocks, which were hit hard during the height of the pandemic selling, reflects the recovery from COVID as energy demand returned, as well as the rotation back into value, Cembalest said.

He still sees “upside” in traditional energy and financials, but believes “a lot of the easy money has already been made.” Within renewable energy, Cembalest said “there needs to be some discipline” and suggested investors “check in” every six months on the expected “commercialization” of companies’ technologies.

“Investors get sloppy in renewable energy,” he said.

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