Did Green Assets Drag Down Value Stocks Over the last Decade?

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    Stockholm (NordSIP) – Despite the coninued popularity of sustainable investments in general and green bonds in particular, one of the main barriers standing in the way of investors is the perception that investors have to accept lower returns from this class of investments.

    Now, new academic research sheds some further light on this issue. According to recent research by Lubos Pastor of the University of Chicago, Robert F. Stambaugh and Lucian A. Taylor of the University of Pennsylvania highlighted by the UN PRI, investors should expect to find lower returns from green assets. The researchers also question what role green assets played in the reversal of the traditional outperformance of value stocks vis-à-vis growth stocks over the last decade.

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    The Discussion

    The argument is the latest in a not-so-straight forward discussion on the nature of sustainable investment returns. On the one hand, ESG investors often argue that sustainable investments should yield longer-term sustainable returns. The recent outperformance of environmentally-friendly stocks vis-à-vis their counterparts at the opposite end of the sustainability spectrum also argue in favour of this perspective. In this line, the stranded assets argument doesn’t just argue in favour of ESG but also against brown investments.

    However, in green bond markets, increasing demand not matched by supply has forced investors to pay a premium for green assets (“greenium”). This issue was highlighted by Peter Lööw, Head of Responsible Investment at Alecta, a Swedish pension provider managing US$125 billion in assets at the 2021 Impact Summit hosted by Phenix Capital.

    “We have a [green bond] portfolio of US$6 billion, which is a large share of our overall portfolio. The problem is that we are seeing very significant demand for green bonds in the Nordics, which pushes the limit on the pricing of those bonds. This is causing us to opt-out of some opportunities these days because they are just too expensive,” Lööw said.

    “We don’t have the mandate to pay that extra premium – the greenium,” Lööw says, referring to the spread between the vanilla bond and its corresponding green bond of equivalent maturity. According to him, Alecta wants to support the green bond market and the opportunity it gives investors to transparently see how their investments are being used while facilitating detailed environmental impact reporting. “The problem is how much you should pay for that. It’s acceptable to pay perhaps one or two basis points (bps), but we have seen instances of 10bps and 20bps. That’s a little bit too much for us.”

    “I’m hoping it’s an issue that supply can fix,” he said noting that the present level of demand is likely to make the issuance of green bonds a standardised and more approachable funding channel for an increasing number of borrowers.

    In their latest study, Pastor, Stambaugh and Taylor’s results elaborate on Löow’s perspective.

    Understanding the Greenium

    According to the authors, investors should expect green assets to underperform brown assets because of higher satisfaction-driven demand and because of green asset’s hedging ability in the face of (increasingly recurrent) adverse climate news, which drives prices upwards and returns down.

    Line graph showing that green stocks outperformed brown ones over the previous decade because their prices rose unexpectedly, and that the realised performance substantially exceeded the counterfactual performance.

    “We compute the rate of return that equates an asset’s current price to the discounted stream of its future payoffs. For a bond, this rate of return is simply its yield to maturity. For a stock, we use its implied cost of capital (ICC), as the expected stock return is not directly observable,” the authors argue.

    “For bonds, starting in 2020, the German government bond market has offered a clean comparison between green and non-green bonds, and the former have consistently had lower yields. For stocks, green stocks consistently had lower ICCs than brown stocks over the previous decade, with their greenness measured using MSCI environmental ratings,” the authors continue.

    Greenium and Value Vs Growth

    The study also offers a new perspective into the reasons why the traditional outperformance of value stocks vis-à-vis growth stocks, patent over the last century, was reversed during the last decade.

    “This historic underperformance of value stocks can largely be attributed to the outperformance of green stocks versus brown. Once we control for our green factor – the theoretically motivated difference between green and brown stock returns – most of this underperformance disappears. The simple reason is that value stocks tend to be brown on average, while growth stocks tend to be green” the authors add.

    “Overall, our findings suggest that investors should not expect to earn superior returns on green assets in the future. Green assets did earn superior returns in the past, but this was driven by unexpected shocks that cannot be expected to repeat in the future” the authors conclude.

    Image courtesy of Quangpraha
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