ESG investment returns face a slowdown

Over the past decade, environmentally friendly stocks have tended to outperform others, backing the case by investors and investment managers for using environmental, social and governance (ESG) criteria. But our research shows that such past performance is the opposite of what to expect in the future. Investors should expect green assets to underperform environmentally unfriendly, or “brown”, assets for two reasons. First, many investors choose to hold a portfolio in line with their values, by allocating more to green assets or divesting their brown holdings. This relatively higher demand means green assets command higher prices, thereby implying lower expected future returns. Second, green assets are a climate hedge, performing better than brown in the face of bad news about climate change. Investors value this hedging ability, resulting in higher prices and lower expected returns for green assets relative to brown. Lower expected returns on green assets show up in the data. A useful case study comes from Germany, whose government began issuing green bonds in 2020. Germany paired each green bond with a non-green “twin” bond with identical cash flows, offering a clean comparison. Read More