Europe’s financial markets watchdog has warned that ESG-labelled investment funds may be particularly vulnerable to looming corrections in the valuations of technology stocks.
The European Securities and Markets Authority (ESMA) said this week that “ESG funds are not immune to concerns over elevated valuations of global equities and especially of AI firms”.
It added that financial products aligned with ‘Article 8’ and ‘Article 9’ of the EU’s Sustainable Finance Disclosures Regulation (SFDR) “tend to be relatively more invested in AI firms” than their peers.
According to ESMA, around 14% of Article 8 and 9 equity fund portfolios are allocated to AI companies. That compares with 10% for funds that claim not to have any ESG characteristics under the SFDR framework.
“This might render Article 8 and 9 SFDR funds more vulnerable to potential corrections in tech firm valuations,” concluded the supervisor.
The comments were made in its latest update on Trends, Risks and Vulnerabilities, published on Wednesday.
It noted that continued market gains in the US, driven by inflows into technology and AI firms, increased market concentration and “raised concerns over the main drivers of US equity valuations and the risk of a disorderly correction”.
Wider concerns over AI
Concerns about a so-called ‘AI-bubble’ have been mounting over recent months.
Kristalina Georgieva, the International Monetary Fund’s managing director, warned that sentiment about AI stocks could “turn abruptly”.
“Today’s valuations are heading towards levels we saw during the bullishness about the internet 25 years ago,” she said during a speech in December.
According to research from Bank of America, 23% of investment-grade credit investors said the threat of an AI bubble was their biggest concern last month – up from just 9% in December.
Data released last week by Motley Fool showed that the seven biggest tech companies in the US, known collectively as the Magnificent Seven, now make up 33% of the entire value of the S&P500.
In order to fund their mammoth capital expenditures into new data centres and projects, many AI-focused businesses are turning to the bond markets.
ESMA said “the increasing reliance of AI firms on debt financing” was a concern “since they rely not only on US public bond markets and private credit, but also utilise asset-backed securities, and off-balance-sheet structures”.
