Has the clean energy theme got too crowded?

Recent pressure on green energy funds could be explained in part by vulnerability in efficient energy index

Has the clean energy theme got too crowded?

After a red-hot reception from investors this year, the clean-energy fund category has cooled significantly.

A recent report from Bloomberg noted that clean-energy ETF inflows in January reached US$5 billion, contributing to the category’s AUM reaching a peak of US$22.3 billion by the end of the month. But over the succeeding three months, such funds faltered as investors pulled cash from the sector at record pace. By mid-May, assets had declined to US$18.1 billion.

That whiplash-inducing swing to underperformance could be attributed in part to excessive crowding in the theme, according to new analysis from MSCI.

In a recent blog post, researchers Anil Rao and Thomas Verbraken said they analysed each of MSCI’s thematic equity indexes to determine what proportion of their constituent holdings were crowded. To do that, they used MSCI’s stock-crowding model that incorporates valuation, trading volume, volatility, momentum, and short interest.

Among the thematic indexes analysed, the authors found that only the MSCI ACWI IMI Efficient Energy Index was substantially crowded. Compared to the MSCI ACWI Investable Market Index (IMI) Growth Index, the efficient-energy index had a greater percentage of crowded stocks by weight as of the end of March 2021 (1% vs. 8%, respectively).

“For reference, this was similar to the level of crowding we saw in smaller-cap U.S. technology stocks in 1999,” the duo said. A look at the efficient-energy index’s history revealed that it became increasingly crowded over the course of 2020, coinciding considerably with the equity markets’ rebound from their March lows.

They then modelled the performance of the efficient-energy theme under three macroeconomic scenarios: reflation, economic overheating, and stagflation. Based on that stress test, they projected that the efficient energy theme would see a return of approximately -40%, compared to -30% for the growth index and -20% for the MSCI ACWI Investable Market Index.

“While stagflation might be considered a lower-probability tail risk, its severity is helpful to further understand the link between crowding and a sharp potential market sell-off,” Rao and Verbraken said.

The efficient-energy theme was substantially more vulnerable under a scenario of stagflation, the two said, because of its overwhelming exposure to style factors. In particular, they determined that momentum and volatility – two factors that rewarded investors in 2020, but have historically been sources of performance shocks in market reversals – contributed the largest potential losses for the efficient energy theme.

“Investors in thematics face a challenge in balancing exposure to long-term trends such as renewable power generation given substantial recent inflows,” the researchers said. “Tools such as crowding scores and stress testing could provide useful insights to help address this challenge.”


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