Thursday, September 16, 2021

Environmental themes and infrastructure bills - Concentrated risk


Within ESG asset management is the sub-strategy of environmental theme investing. Instead of focusing on the overall ESG rating based on criteria set by any number of firms, investors buy into themes that are associated with key ESG sectors like alternative (clean) energy and technology which includes wind and solar or electric cars and batteries as well as other infrastructure investing. This technology may not be cost efficient until there are better economies of scale. Scale is reached through mass production. The average and marginal cost will fall if there is greater demand often created from subsidies by the government. The subsidies can come in many forms, but all require legislation or regulatory changes. 

Looking at leading clean energy ETFs (KLN, PBW, and FAN) shows the concentration of investment risk around subsidies and government support. After the presidential election, the component stocks of these clean ETFs rose under the expectations of a huge green new deal. As the possibility of an infrastructure deal declined, returns declined to current levels. Investors in the clean energy ETFs are not just buying technology but making a play on the green energy bill that will create scale opportunities. If the stock prices rise, it is signaling a higher probability of legislative success.

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