New academic research has found that carbon-efficient firms outperform their carbon-inefficient peers – though investors don’t consider this in their decision-making.
The findings – which the authors say have “profound” implications — suggest that an investment strategy of ‘long carbon-efficient firms and short carbon-inefficient firms’ would earn abnormal returns of 3.5-5.4% a year.
It “strongly indicates the outperformance of carbon-efficient firms may be a long-term sustainable trend,” note the researchers in a working paper for the Stanford Global Projects Center.
It was supported by the United Nations Environment Programme (UNEP) Finance Initiative Portfolio Decarbonization Coalition and the Sovereign Wealth Fund Research Initiative; it used carbon emissions data provided by Trucost.
The 68-page paper is called Being Green” Rewarded in the Market? An Empirical Investigation of Decarbonization and Stock Returns. It was put together by Soh Young In, Ki Young Park and Ashby Monk, Executive and Research Director of the Stanford Global Projects Center and a Senior Advisor to the Chief Investment Officer of the University of California. Monk is one of the most influential academics covering institutional investment. His co-author Ki Young Park is Associate Professor of Economics at Korea’s Yonsei University. Soh Young In is a PhD student.
The researchers note that potential investment by pension funds and others in climate change mitigation has been hampered by an “unclear relationship” between corporate environmental performance and financial performance.
To remedy this, the study investigates the risk-return relationship of low-carbon investment, and characteristics of carbon-efficient firms. The aim is to “provide reliable evidence” on the market evaluation of low-carbon investment.The paper says: “We find that carbon-efficient firms are likely to be ‘good firms’ in terms of financial performance” (using a variety of measures) and corporate governance.
But it also says investors don’t recognise this yet: “However, we do not find strong evidence that investors explicitly consider carbon efficiency in their investment decision.” But it’s hoped the new findings “are promising enough to encourage investors, business leaders and policymakers to modify their approach to low-carbon investment”.
“Long-term fiduciaries ignoring environmental risks is particularly nefarious”
The paper says it has been difficult to convince investors of the financial legitimacy of climate and environmental risks, which get relegated to the “underappreciated pile” tagged ‘extra-financial’.
Indeed, it notes the widespread perception that explicitly managing environmental risks could reduce investment returns.
“This dynamic of long-term fiduciaries ignoring environmental risks is particularly nefarious,” the paper states.
But it includes an upbeat thought: “And yet, if we could show that carbon-efficient firms do outperform carbon-inefficient firms, then we could actually flip this negative dynamic into a combination of mutual reinforcing solutions in which the path to secure the retirements of our ageing population explicitly encourages the transformation of our economy into one that is carbon efficient.
“That is precisely what we attempt to test in this paper and why we believe the implications of our findings are so profound.”