Central bank of the central banks: is there a “green bubble” in the financial markets?

In its current quarterly report, the Bank for International Settlements (BIS), as it were the central bank of the central banks, deals with the question of whether a “green bubble” is looming on the financial markets.

The authors Sirio Aramonte and Anna Zaba describe the strong inflows into investment products around the label "ESG" ("Environmental, Social and Corporate Governance").

Above all, the topic of the environment is important to many investors, supported by appeals from the media and politics.

Christian Siedenbiedel

Editor in business.

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“At the same time, in view of the very rapid growth of the new asset class, the question arises whether a bubble could not form if market transparency cannot be guaranteed,” write the economists: “Could be a generally welcome development - support for the financing of the transition a low-carbon world - lead to significant financial imbalances? "

The authors look at the growth of this asset class using various numbers. The exact quantification is not easy because of the unclear delimitation. According to estimates with a broad definition, ESG assets increased by nearly a third between 2016 and 2020 to $ 35 trillion, or 36 percent of total professionally managed assets. Other estimates only took into account those funds and ETFs, i.e. exchange-traded index funds for which the issuers themselves speak of investment mandates that take ESG or SRI (socially responsible investment) into account. According to the definition, growth is even faster, but from a lower level. The assets managed by these funds have therefore increased more than tenfold over the past five years to around $ 2 trillion.Equity funds based on ESG or SRI accounted for around 3 percent of assets under management, and ESG bond funds based on these criteria for around 1 percent.

Limited disclosure requirements left an incomplete picture of which investors were holding the assets.

In the case of American insurance companies and European banks, the stocks probably only made up a small part, around 1 percent.

In the case of American pension funds, for example, the shares have increased significantly since 2017 and now account for around 4 percent of their exposure to corporate loans.

Lessons from the financial crisis

Historical lessons from investment volumes and price dynamics in fast-growing asset classes could be important for ESG stocks, the report said. "Assets associated with profound economic and social changes tend to experience large price corrections after an initial investment boom." Railroad stocks in the mid-18th century, Internet stocks during the dot-com bubble, and mortgage-backed securities during the global financial crisis are examples of this.

"It is therefore noteworthy that the growth and size of the private label MBS market prior to the financial crisis is comparable to that seen more recently for ESG retail and exchange-traded funds," the report said. There are indications in some segments that the valuations of ESG assets may be exaggerated: For example, the price / earnings ratio of companies in the renewable energy sector is still well above that of, even after falling from the high in January 2021 already highly valued growth stocks. That must at least be observed. If the market continues to grow at this pace and increasingly sophisticated instruments emerge around this asset class, it will not only be importantevaluate the benefits of funding the transition to a low carbon world - but also identify the financial risks.

How dangerous is inflation?

The BIS has also scrutinized the loose monetary policy of the world's central banks in view of the rise in inflation - but the results are generally reassuring.

Much of the price change is concentrated in a few economic sectors in an environment with long-term low inflation.

This suggests that the recent sharp rise in inflation is a temporary phenomenon.

The BIS thus supports the arguments of many large central banks.

The US Federal Reserve (Fed) and the European Central Bank (ECB), for example, do not consider the current rise in inflation to be permanent and therefore want to keep their monetary policy relaxed.

They argue with corona-related special effects and so-called statistical base effects due to low comparative values ​​in the previous year.

In its study, the BIS examined price developments in 131 sectors of the American economy over a long period of time.

It is of the opinion that the results can in principle be transferred to other economies.