Stocks considered as “more ESG” or environmental, social and governance have been persistently more expensive since 2014, and that valuation gap has recently been widening in the US, according to a report from Barclays.
Lesser ranked ESG stocks have shown signs of cheapening as investors preferred green assets.
The report cites data from Morningstar which shows that assets in global sustainable funds reached $2.7 trillion at the end of last year, up from $1.8 trillion in 2020 and $1 trillion in 2019.
As a result, investors have become concerned over whether valuations of ESG-related stocks may have become pricey and exposed to an undesirable anti-value bias.
“This leads to a natural question: how to incorporate ESG into a portfolio without increasing exposure to highly valued growth stocks?” said Barclays.
The study plotted CAPE (cyclically adjusted price-to-earnings) ratios from December 1981 to May 2022 and found that markets have become more expensive.
The current CAPE of the European stock market is still almost as high as just before the financial crisis and US stock market valuations exceed pre-crisis levels.
Barclays said: “As many as 7 out of 10 sectors in the US and Europe are highly valued, featuring among the top 25th percentile from a CAPE ratio perspective. In both regions those sectors include energy, materials, industrials, health care, utilities, and technology.”
The study analysed differences in valuations between all common stocks quoted on NYSE and Nasdaq for the US, and the major developed countries and exchanges in Europe, with different ESG Risk Ratings from Sustainalytics, the sustainability data provider.
ESG stocks were classified as negligible, low and medium risk, and high and severe risk companies as non-ESG. The sample period is between December 2014 to January 2022, which is the time for which Sustainalytics provides their current ESG Risk Ratings.
ESG stocks were found to be more highly valued than non-ESG companies in the US and Europe. Barclays said, “We show that stocks with negligible, low or medium ESG risk according to Sustainalytics have been persistently more expensive than companies with high or severe risk.”
In addition, the report found stocks that are usually excluded by investors in negative ESG screening, such as companies involved in controversial businesses or that are non-compliant with United Nations Global Compact, have been generally cheaper than all other stocks.
“However, we find no evidence of ESG stocks being generally more expensive than non-ESG stocks within sectors, which suggests that the overall ESG/non-ESG valuation differences are driven by factors other than perceived ESG risk, such as differences in sector valuations themselves,” added Barclays.