Why ESG Funds Have Outperformed

The rising popularity of ESG investing has driven asset flows to green stocks. But new research confirms that the resulting higher valuations forebode lower returns for climate-conscious investors.

Many consider climate change to be one of the biggest challenges of our time. Investors are expressing their concerns by dramatically increasing investments in companies with good ESG scores. According to the 2020 Report on U.S. Sustainable and Impact Investing Trends, ESG investing now accounts for more than one-third of total assets under management in the U.S., or about $17 trillion, a 42% increase since 20181.

David Ardia, Keven Bluteau, Kris Boudt and Koen Inghelbrecht contribute to the sustainable investing literature with their February 2021 study, “Climate Change Concerns and the Performance of Green Versus Brown Stocks,” in which they tested the hypothesis of Lubos Pastor, Robert Stambaugh and Lucien Taylor, authors of the August 2020 paper, “Sustainable Investing in Equilibrium,” that because of increased cash flows, green firms outperform brown firms when concerns about climate change increase unexpectedly.

Their database consisted of S&P 500 companies and covered the period January 2010 to June 2018. To capture unexpected increases in climate change concerns, they constructed a media climate change concerns (MCCC) index using news about climate change published by eight major U.S. newspapers. Their index measured the level of negativity as well as the level of risk and uncertainty discussed in each article. To quantify a firm’s greenness, they relied on the ASSET4/Refinitiv carbon-dioxide-equivalent (CO2-equivalent) greenhouse gas (GHG) emissions data scaled by firms’ revenue. The variable measures a firm’s emissions intensity, i.e., the number of tons of CO2-equivalent GHG emissions necessary for a firm to generate $1 million in revenue. Firms below the 25th percentile are defined as green, and those above the 75th percentile are defined as brown.