Green stocks don't perform as well as investors hope
One could reasonably take the position that a company better poised to manage the changing environmental future would deserve to be priced higher. For at least a decade this has been the fundamental economic theory of die-hard ‘pro-green’ investors. Let’s call it the ‘simple green stock theory’; green stocks deserve to be priced higher because they are preparing for climate change (a “climate risk premium”). In turn this will return more for stockholders because the companies will be better prepared for the environmental apocalypse to which we are heading. One didn’t even need to believe it was the right thing to do morally. Green companies (as a whole) would do better regardless of where you are on the political spectrum of climate change.
Contrarians of the simple green stock theory have argued that green stocks are priced beyond anything that economic valuation can justify. Demand for green assets is greater than supply. Some call it a bubble. Social and political interest in environmentally conscious companies is driving shareholders to buy at ever higher prices, but there is no (reasonable) model to justify it as an investment.
The die-hards have won resoundingly so far. By some measures, big green firms have done twice as well as the SP500 over the last decade. The results are even higher if you look at small green companies. What’s not to like about saving the planet and making great returns on your investments at the same time? I want to believe this works, but there is growing evidence the contrarians have a point.
First a quick point that I wrote about before: There are many charlatans out there selling bullshit promises about returns and ‘greenness’. US and European regulators are signaling a crackdown but it’s likely still a long time away because the space is complex and developing good regulations is slow. Both the die-hards and the contrarians agree there is fraud and misrepresentation out there for which solid research and healthy skepticism is the only remedy. Let’s put that issue aside.
Award winning research by professors at University of Chicago and University of Pennsylvania is giving support that future returns of green stocks will be lower than the stock market. In their empirical follow-up paper to their original theoretical paper, the authors showed that green asset price increases could be ~80% explained by the rapid growth in awareness of the oncoming environmental calamity, greater news coverage of climate change, and public exposure to information about how companies are adapting.
They did this by examining U.S. Newspaper articles over the last eight years and identifying periods when climate concerns strengthened. They found it was in these periods that green stocks recorded most of their outperformance over the stock market. They also found that ‘brown’ stocks, those that are non-green, did worse in those periods. Said author Lucian Taylor, “Basically, when there’s really bad news about climate change, green stocks outperform and brown stocks underperform.”
So why would this end? Well, maybe it won’t. However, it’s strong reason for caution. Awareness of climate change has increased rapidly in recent years. (1) (2) (Note: ‘Awareness’ does not mean there is an ‘adequate response,’ it’s merely media saturation.)
As awareness becomes more common, the authors predict green assets will perform worse than recent years. They do not believe there is a climate change premium.
