Coloring the Results

Greg Spears

GREEN INVESTORS TRY to manage their portfolios in ways that are good for the Earth. But are they rewarded with good investment returns? Researchers believe the answer is a qualified “yes,” according to a new paper titled “Dissecting Green Returns.”

The paper found that, between 2012 and 2020, U.S. green stocks delivered higher returns than environmentally unfriendly “brown” companies. But the paper argues this outperformance—which averaged about 0.65% a month—is unlikely to persist.

“Past performance is not a guarantee of future performance, and we think that caveat is especially well heeded in green investing,” says Robert Stambaugh, finance professor at the University of Pennsylvania’s Wharton School, and one of three principal authors. Their paper won this year’s $10,000 best paper prize from Wharton’s Jacobs Levy Equity Management Center.

In a Zoom conference earlier this month, Stambaugh offered two reasons for green shares’ outperformance. First, green companies profited from unexpectedly high demand for their goods, as consumers reacted to bad news about the environment.

Second, investors pay a premium for green shares. For proof, Stambaugh cited two bonds issued by the German government in 2020. One bond series funded only green projects, the other conventional government projects. Although the two bonds are identical, investors pay more for the green bonds—and accept lower yields as a result.

Therein lies a problem. Investors may bid up green shares so they’re above their intrinsic worth, paying what Stambaugh called a “greenium.” If so, green shares could underperform brown going forward, especially if there’s unexpected good news about the environment, he said.

The researchers used MSCI’s environmental rankings to categorize green and brown companies. Those that scored in the top third on environmental measures were categorized as green. Those in the lowest third were deemed brown. The companies were not scored on the social and governance measures typically used by socially conscious funds.

Their green definition also may not fit the conventional mental model of green firms being all about windmills and solar panels. The five greenest industries were asset management, professional services, telecommunication services, consumer finance, and health care equipment and supplies. The five brownest sectors were the usual suspects: commodity chemicals, diversified chemicals, oil and gas exploration and production, steel, and metals and mining.

Investors’ preference for green shares may help unpick another stubborn investing puzzle. “Green outperformance explains much of the historic underperformance of value stocks over the last decade,” Stambaugh observes. “Value stocks tend to be browner, and green tend to be growth.”

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1 year ago

While interesting, I think it should be noted that this paper had yet to undergo peer review.

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