Hedge fund managers are piling into short positions in ESG stocks as they hunt for bogus green claims and valuations inflated by record stimulus.

Bloated prices can be found “all over ESG,” according to Soren Aandahl, the founder and chief investment officer of Texas-based Blue Orca Capital LLC. He says he didn’t set out to target ESG but, here and now, the “great shorts just happen to be in the ESG space.”

There’s “so much capital chasing” ESG assets, but there are “so few good ideas,” Aandahl said in an interview. He argues that using short positions to expose bad bets “will actually make a positive difference for the earth and environment.”

Companies making environmental, social and governance claims are bumping up against an increasingly skeptical wall of investors looking for more than just lofty ESG talk. That’s as ESG and sustainability statements full of hard-to-quantify language become ubiquitous across the corporate landscape.

Regulators are racing to put in place frameworks that limit ESG hype, but the process is drawn out and hampered by legal challenges in the US. Hedge funds, meanwhile, may offer a faster route to exposing greenwashing.

Blue Orca rose to prominence in 2018 when its criticism of corporate governance at Samsonite International SA led to the resignation of the luggage maker’s chief executive officer. Announcements that it’s shorting a stock often get followed by flash selloffs.

Stocks currently being shorted by Blue Orca include Enviva Inc., a biomass fuel producer that has an ESG rating of “A” at MSCI. It’s down almost 90% this year, after suffering losses amid reported maintenance and operational issues.

Other shorts include Li-Cycle Holdings Corp., a battery recycling special purpose acquisition company whose market value is down about 20% this year as lithium and cobalt prices fall.

Aandahl is far from alone in shorting ESG stocks, as hedge funds zero in on companies that were supposed to benefit from climate stimulus packages such as the Inflation Reduction Act. Their short bets are turbo-charging a wider selloff in several categories of green stocks that are being pummeled by everything from higher interest rates to supply-chain bottlenecks.

The IRA, which was signed into law by President Joe Biden in August 2022, may end up channeling as much as $3.3 trillion into renewable technologies and other green assets over the coming decade, according to analysts at Goldman Sachs Group Inc. Environmentalists and Wall Street heavyweights such as JPMorgan Chase & Co. are among those betting the law will be a game changer for the green economy.

But here and now, investors are increasingly trying to figure out which companies — and in some cases whole sectors — will falter once the effect of those subsidies fades. Argonaut Capital Partners is shorting green hydrogen stocks and some wind turbine producers, while Geneva-based Anaconda Invest is short solar stocks in the US.

David Allen, head of long-short strategies at Australia-based hedge fund Plato Investment Management, says he has over 100 ESG “red flag” metrics that he screens for before placing a bet. He’s among short sellers to have made a combined $111 million this year through Sept. 21 by betting against GCL Technology shares, according to data provider Ortex.

Funds shorting solar battery storage manufacturer Enphase Energy Inc. and inverter maker SolarEdge Technologies Inc. made about $1.5 billion in total over the same period, the data show.

Even hedge funds whose strategies are dedicated to supporting renewable energy have acknowledged that some green sectors look bleak at the moment. Per Lekander, chief executive of London-based hedge fund Clean Energy Transition, says the wind turbine industry now needs “a complete reset” as investors face a “very long period with very disappointing growth.”

Hitomi Kimura, an analyst at Bloomberg Intelligence, says the slump in clean energy stocks over the past year is in large part due to “macro drivers” rather than “fundamentals.” But the upshot is that some may end up being removed from exchange-traded funds. A case in point, according to Kimura, is Taiwanese solar conductive-paste maker Gigasolar Materials Corp.

“Rising short interest — up to 67% for Gigasolar — has likely contributed to violating the required market cap and liquidity rules to be retained as ETFs,” she said in a Sept. 15 note. “Yet most of these companies remain profitable, with 15-30% margins, suggesting their underperformance has been driven by sector headwinds, including rising borrowing costs for the sector’s high investment needs.”

Companies Facing Potential Clean-Energy ETF Exit

Aandahl at Blue Orca says it’s now clear that the vast sums of cash being made available for ESG stocks are propping up some companies that wouldn’t survive on their own.

Climate stimulus is feeding “an asset bubble in this space” and sustaining some “completely terrible companies,” he said.