JPMorgan's equity chief told us why ESG investing is 'a bubble in the making' — and explained how to avoid the reckoning when it bursts

  • ESG investing is “a bubble in the making” because investors are not paying enough attention to company fundamentals, according to Dubravko Lakos-Bujas, JPMorgan’s chief US equity strategist and global head of quantitative research.
  • In an exclusive interview, he discussed why he sees a potential crowding issue in stocks that rank highly on environmental, social, and governance standards.  
  • He also explained the methodology that went into creating a screen of ESG stocks to avoid in 2020.
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Environmental, social, and governance standards have long guided investing decisions because they impact how companies perform on the stock market.

But 2019 was an explosive year for ESG investing. As people paid more attention to issues including climate change and gender equality, investors chased companies that were seen to espouse social ideals. They poured more than $4 billion into US ESG funds in each of the first three quarters of last year, compared to $5.5 billion in all of 2018, according to Morningstar data.

This boom has taken place “too far too fast” according to Dubravko Lakos-Bujas, JPMorgan’s chief US equity strategist and global head of quantitative research. He says investors should now question the extent of crowding that exists within the ESG complex. 

“People have gone into ESG without paying enough attention to fundamentals,” he told Business Insider during a recent interview. “And I would as a result say ESG is a bubble in the making.”

He is wary of companies that have strong ESG credentials — and even the stock-market outperformance to show for it — but are now overvalued relative to fundamentals.

To capture this theme, his team constructed a Disconnected ESG Basket of stocks that they recommend investors short, or bet against, in 2020.

These Russell 3000 companies are all high ESG scorers that have outperformed their sectors by more than 5%. However, they fare worse than their peers on fundamental metrics including sales growth, earnings growth, and return on equity.

Names such as Chipotle, Crocs, Kansas City Southern, and IHS Markit are in the basket. 

The basket also filters for stocks where environmental and social rankings are higher than the governance component of ESG. 

Lakos-Bujas explained that governance — which involves who runs a company, how they lead, their compensation, how much voting power they wield, and so on — has a longer history as a yardstick on investors’ checklist. For example, one feature of so-called quality stocks that produce reliable profits is low turnover in the upper management ranks.   

While environmental and social considerations have recently gained a lot of traction as yardsticks for quality, their validity is questionable, in his view. 

“Just because a company ranks better on ‘E’ or ‘S’ issues doesn’t mean that the company is more profitable,” he said.

He added, “And if anything, back tests suggest that these two factors often times generate negative alpha.” 

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