"ESG" orphans bets on mean reversion
ETF newcomer Constrained Capital has launched an ETF that targets stocks that are usually binned by ESG funds.
The Constrained Capital ESG Orphans ETF (ORFN) is self-indexed. It tracks the ESG Orphans index, which is built by Constrained Capital and calculated by Solactive.
The index uses FactSet's RBICS system to pick six sectors it believes are most heavily excluded by ESG funds. These are: fossil fuels, nuclear power, tobacco, weapons, alcohol and gambling. Any US listed company is eligible.
The fund then picks the largest companies in each RBICS sector, subject to caps of 12 stocks for each sector and 10% index weight for each stock.
Tidal ETF Services provides white labelling to Constrained Capital.
The fund charges 0.75%.
Bernie's commentary - the market has to respond
I remember during the 2015 British General Election campaign Ed Miliband, the Labour Party leader, spoke with Russell Brand, the actor. Brand asked Miliband why any leftist should vote for him, given how similar Labour was to the Tories. Miliband replied: "because politics has to respond".
What Miliband meant by this was that if you're a leftwinger, like Russell Brand, and you want to change the world, you cannot do it without politics. You can win every argument and identify every injustice. But if politics doesn't respond you're going nowhere. That Miliband was more likely to respond to Brand's political demands than David Cameron, then-leader of the Tories, was left unsaid.
What's this got to do with ESG orphans? The dynamic of the stock market is similar to politics. A lot of people buying ESG orphans correctly believe they have been oversold. Correctly believe ESG orphans are being unfairly ostracised. (Is nuclear energy really that bad?) Correctly believe their fundamentals demand better prices. The facts are on their side.
But at the end of the day, if you want a company's share price to rise, the market has to respond. Fundamentals can continue improving while share prices continue cratering. Look at what happened to Amazon from 1999 - 2002. Improving fundamentals is not a sufficient condition for share price growth for publicly traded companies. Market perceptions matter just as much, if not more.
This all matters for ESG orphans because they are currently being removed from institutional investors' portfolios. Pension funds, worried about public perceptions, are adopting ESG mandates in record numbers. Meaning the market for these ESG orphans is in structural decline. In other words, what Ed Miliband told Russell Brand may be relevant here. Constrained Capital can be right about facts, but as ESG mandates grow investors simply may not care or respond.
