Skip to main content
PGIM Quantitative Solutions LogoPGIM Quantitative Solutions Logo
  • About Us
    • Our Philosophy
    • Our History
    • The Team
    • Diversity, Equity & Inclusion
    • Contact Us
  • All Insights
    • ESG
    • Market Views
  • ESG Overview
    • ESG Insights
    • ESG Policy
    • Stewardship and Governance
  • Overview of Solutions
    • Quantitative Equity
    • Multi Asset
    • PGIM Wadhwani
    • PGIM DC Solutions
  • Client Log In
  • Careers
Soapy Bubbles
ESG

Navigating the ESG Bubble: The Deal with DataNavigatingtheESGBubble:TheDealwithData

By George N. Patterson — Aug 15, 2022

5 mins

Share
  • Mail
  • LinkedIn
  • Twitter
  • Copy URL
Download PDF

Share

Despite recent headlines and heightened regulatory scrutiny about greenwashing, ESG remains on the forefront of investors’ minds. As demand for ESG continues to grow, finding “good” ESG companies is taking center stage. But could this search for “good” companies lead to an ESG bubble as an ever-growing volume of investors pile assets into a still-limited number of companies meeting stated ESG criteria?

Let’s take a look at how this could play out:

Strict regulatory guidelines related to ESG goals are taking shape. Stemming from the Paris Agreement, which aims to reduce greenhouse gas emissions and limit global warming to 1.5 degrees Celsius per year, as regulations expand and become more stringent, demand for ESG investing increases, yet the market segment of companies able to meet those standards remains limited. For example, a focus on sustainability has expanded the demand for companies with policies and operations aligned with the “E” in ESG, which typically means investors are seeking exposure to firms with a demonstrable commitment to net-zero carbon emissions. But the number of companies currently able to meet the strict regulations for net-zero is quite small. When assets in search of ESG pour into that limited subset of companies, their prices become inflated and valuations naturally rise. And we know that when demand greatly exceeds supply, companies become overvalued. With enough investors chasing the same firms, a bubble could emerge. And even without bubble-levels of craziness, extended valuations among ESG firms are likely to serve as performance headwinds.

Similarly, aligning with Europe’s prescriptive Sustainable Finance Disclosure Regulation (SFDR) indicators for sustainability can lead to a relatively small number of investment options given their narrow definitions. The limiting nature of this taxonomy could precipitate a scenario of an ever-increasing amount of assets chasing a static number of investment opportunities.

So how are investors expected to navigate a scenario in which third-party classification of ESG companies can lead to investing in overpriced stocks? Having an investment partner who can identify attractive ESG investments while paying attention to the value of ESG firms, rather than investing based solely on ESG metrics, is a good start. Investing in “ESG at a good price” rather than “ESG at any price” lessens the potential issues of crowding into stocks.

Let’s take the example of limiting emissions. Rather than solely investing in firms categorized as already meeting net-zero emissions goals, a manager with a data focus can create screens for companies that have set targets and have taken steps to decarbonize. Utilizing “glidepaths” and models to determine whether firms are decarbonizing at a rate that puts them on a trajectory to meet set emissions targets can be useful. But as these approaches and definitions of alignment become increasingly more common, this can lead to a large degree of overlap and potential crowding, again leading to overvaluation. Instead, screening for recent behavioral changes that have resulted in decreased emissions by a company that would otherwise fall into the “high carbon emitter” category allows the inclusion of companies that are on track to meet net-zero targets. Investing in companies coming into alignment with ESG goals can lead to lower overall carbon emission portfolios than by relying only on ESG index constituents.

Data screening, scalability, and a discerning approach to stock classification help to identify differentiated opportunities that indexing or fundamental investing would likely miss. This broader scope of opportunities provide for portfolio construction across a truly global ESG universe. By employing a differentiated stakeholder framework not bound by strict definitions, quants establish a holistic approach to analyzing companies’ management and operations, their interaction with stakeholders, and their exposure to risk. This approach can serve an important role in uncovering value in the ESG space while navigating a potential bubble in ESG investing.

Download PDF
  • By George N. PattersonChief Investment Officer, PGIM Quantitative Solutions
  • About Us

    • Overview
    • Our Philosophy
    • Our History
    • The Team
    • Inclusion & Diversity
    • Contact Us
    • Careers
  • Insights

    • Overview
    • ESG
    • Market Views
  • ESG

    • Overview
    • Insights
    • ESG Policy
    • Stewardship and Governance
  • Solutions

    • Overview
    • Quantitative Equity
    • Multi Asset
    • PGIM Wadhwani
    • PGIM DC Solutions
PGIM Quantitative Solutions Logo
  • Terms & Conditions
  • Privacy Center
  • Accessibility Help
  • Cookie Preference Center

For Professional Investors only. All investments involve risk, including the possible loss of capital.

The content and materials presented here are for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation in respect of any products or services to any persons who are prohibited from receiving such information under the laws applicable to their place of citizenship, domicile or residence. PGIM Quantitative Solutions LLC (PGIM Quantitative Solutions or PGIM Quant), formerly known as QMA LLC, is an SEC-registered investment adviser and a wholly-owned subsidiary of PGIM, Inc. (PGIM), the principal asset management business of Prudential Financial, Inc. (PFI) of the United States of America. Registration with the SEC does not imply a certain level of skill or training. PFI of the United States is not affiliated in any manner with Prudential plc incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. 

In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V. with registered office: Gustav Mahlerlaan 1212, 1081 LA Amsterdam, The Netherlands. PGIM Netherlands B.V. is authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited under temporary permission arrangements following the exit of the United Kingdom from the European Union. 

These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II). PGIM Quantitative Solutions, PGIM Limited and/or PGIM Netherlands B.V. are indirect, wholly-owned subsidiaries of PGIM. These materials are not intended for distribution to, or use by, any person in any jurisdiction where such distribution would be contrary to local or international law or regulation.

In Japan, investment management services are made available by PGIM Japan, Co. Ltd., ("PGIM Japan"), a registered Financial Instruments Business Operator with the Financial Services Agency of Japan. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 (paragraph (a) to (i) of the Securities and Futures Ordinance (Cap.571). In Singapore, information is issued by PGIM (Singapore) Pte. Ltd. (“PGIM Singapore”), a Singapore investment manager that is licensed as a capital markets service license holder by the Monetary Authority of Singapore and an exempt financial adviser. These materials are issued by PGIM Singapore for the general information of “institutional investors” pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) and “accredited investors” and other relevant persons in accordance with the conditions specified in Sections 305 of the SFA. In South Korea, information is issued by PGIM Quantitative Solutions, which is licensed to provide discretionary investment management services directly to South Korean qualified institutional investors on a cross-border basis.

PGIM, PGIM Quantitative Solutions logo and the Rock design are service marks of PFI and its related entities, registered in many jurisdictions worldwide.

© 2023 PGIM Quantitative Solutions. All Rights Reserved.
 

You are viewing this page in preview mode.

Edit Page