By LARRY SWEDROE
Investors are expressing their concerns about climate change by dramatically increasing investments in companies with good environmental, social and governance (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 2018. An interesting question is: Does media attention affect investor asset allocation decisions?
Media attention can affect investor decisions, as greater coverage of environmental news might reflect, or lead to, increased public awareness of environmental problems — the greater the coverage, the greater might be the level of concern and vice versa. In addition, media coverage of environmental issues can capture environmental risk — the media pays more attention to environmental news when there is an increase in ecological disasters or new regulations to address climate change. With the reporting of such news, investors become more aware of these risks and turn away from “brown” assets with exposure to such hazards in favor of “green” assets.
Marie Bessec and Julien Fouquau contribute to the sustainable investment literature with their September 2021 paper, A Green Wave in Media, a Change of Tack in Stock Markets, in which they analysed the impact of green sentiment in U.S. media on financial markets. Using textual analysis with a dictionary-based approach (consisting of 745 words), they compiled several scores of attention, tonality and uncertainty in the coverage of environmental news of four major U.S. newspapers. Their database included more than 126,000 articles. They considered various weighting schemes to account for the visibility and relevance of the text sources and several sets of newspapers to measure the possible impact of their editorial line.
Their first environmental indicator measured media attention, or “buzz”, as the frequency of occurrence of the environmental terms. They then proposed two additional sentiment indicators that took into account the tone or uncertainty of the articles. Their third score combined the three dimensions (attention, tonality and uncertainty). They also investigated the impact of the relevance and visibility of the news. Considering the different weighting schemes in the calculation of these scores and the different databases, they measured 30 different scores to disentangle the impact of attention, media tone and possible editorial bias.
The researchers’ hypothesis was that their green scores should reflect environmental risk and investors’ preferences for sustainable assets. To test this hypothesis, they examined whether coverage of environmental news adversely affected the average returns and volatility of energy stocks and reinforced the taste of investors for green assets.
They assessed the impact of environmental news on eight stock indices: four green indices that covered firms with good environmental performance and four brown indices related to the energy sector. The group of green indices included the S&P 500 Net Zero 2050 Climate Transition ESG Index (387 stocks) and the S&P 500 Paris-Aligned Climate Index (349 stocks), which are the most likely to react to environmental news. These two indices were launched in June 2020 and were retropolated until 2017. The third green index, the S&P 500 Fossil Fuel Free Index, was available from January 2012 and includes the 490 constituents of the S&P 500 that do not own fossil fuel reserves. The fourth indicator in the green category was the S&P 500 ESG Exclusions II Index. This index is not restricted to satisfying environmental criteria only. It includes 485 S&P 500 firms that are not involved in the controversial weapons, small arms, tobacco products or thermal coal industries.
The four brown indices were: the S&P 500 Energy Index (24 of the S&P 500 constituents in the energy sector according to the GICS classification); the S&P Commodity Producers Oil and Gas Exploration and Production Index (45 firms from nine countries); the 12 U.S. companies in the S&P 500 that are classified in the commodity producer oil and gas exploration and production subcategory; and the 10 most highly polluting U.S. companies in the energy and utility sectors according to their Newsweek green ranking. Their data sample covered the period January 2010-January 2020 in order to avoid the exceptional effect of the COVID-19 pandemic. Following is a summary of their findings:
- There was a negative impact of media coverage on energy stock indices, indicated by a reduction in their mean returns and an increase in their volatility. The opposite result held for the most climate-friendly stocks.
- Brown stocks were more penalised than green ones were rewarded.
- The impact was stronger for the green scores taking into account the tonality of the news and those retrieved from less conservative newspapers.
- The peaks in the scores coincided with serious environmental disasters (e.g., the Fukushima Daiichi nuclear disaster in March 2011, hurricanes Harvey and Irma in September 2017 and, more recently, wildfires in California and Australia). The scores also showed peaks during environmental summits (e.g., COP 21 in Paris in late 2015) or when the EPA announced new environmental regulations to reduce carbon emissions (e.g., the Clean Power Plan, first proposed in June 2014 and designed to reduce pollution from existing power plants).
- A positive shift in green sentiment was also associated with a significant increase in the volatility of brown indices, while the fluctuations in green indices decreased. One notable exception in the green selection was the ESG index, which is rarely affected. This finding may be related to the fact that the ESG index consists of a selection of stocks based on a larger set of criteria than only environmental ones.
Their findings led Bessec and Fouquau to conclude that “rising environmental concerns lead investors to shift their asset allocation.” They added: “Greater coverage of environmental news has a strong adverse impact on the returns and volatility of brown indices, whereas the most virtuous green indices are positively affected.” They further noted: “Our findings are likely to reflect both changes in investors’ expectations about firms’ future cash flows and shifts in their preferences for green assets in response to greater coverage of environmental news.”
Importantly, other researchers have documented that green stocks outperform stocks of carbon-intensive firms when climate concerns increase and that the media can contribute to this increase. For example, Lubos Pastor, Robert Stambaugh and Lucien Taylor, authors of the August 2020 paper Sustainable Investing in Equilibrium, hypothesised that even though brown stocks have higher ex-ante expected returns because of increased cash flows, green firms can outperform brown firms when concerns about climate change increase unexpectedly. In their follow-up September 2021paper, Dissecting Green Returns, Pastor, Stambaugh and Taylor empirically confirmed their hypothesis. After constructing a theoretically motivated green factor from U.S. stock data, they showed that green stock outperformance disappeared when a text-based measure of media concern about climate change was controlled for.
Also testing Pastor, Stambaugh and Taylor’s hypothesis, in their February 2021 study Climate Change Concerns and the Performance of Green Versus Brown Stocks, David Ardia, Keven Bluteau, Kris Boudt and Koen Inghelbrecht found that when concerns about climate change increased unexpectedly, green stock prices increased, while brown stock prices decreased. This relationship was stronger, in absolute terms, for the brown portfolio than for the green portfolio — when there was an unexpected increase in climate change concerns, investors tended to penalise brown firms more than they rewarded green firms. They also found that climate change concerns affected returns both through investors updating their expectations about firms’ future cash flows and through changes in investors’ preferences for sustainability.
The bottom line is that the research has found that green sentiment in the media has a negative impact on the mean returns of brown stocks and amplifies their volatility. The opposite result holds for climate-friendly stocks.
With that said, you should keep in mind that the period (January 2010-January 2020) studied by Bessec and Fouquau was one in which energy stocks had poor returns. Those poor returns may have had more to do with excess supply from fracking, which led to high competition and low prices, than the shift in the demand from brown to green stocks. For example, Brent crude oil began the period at about $80 a barrel, and after peaking at about $120 a barrel in early 2012, it began a precipitous slide to under $30 in early 2016 and ended the period at about $60. Thus, over the period, oil prices fell significantly, even in nominal terms. The result was that over the period January 2010-January 2020, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) lost 7.14 percent per annum, while the Vanguard S&P 500 ETF (VOO) returned 14.07 percent per annum, an underperformance of 21.21 percentage points per annum.
However, Bessec and Fouquau analysed the returns and volatility of the stocks on a weekly basis. Thus, even though there was a negative trend over the last decade on the energy stock prices, their data captured the short-run impact of the environmental news.
There is strong evidence that media attention impacts investor allocations to green and brown stocks and thus their valuations. If ESG concerns strengthen unexpectedly, green assets could outperform brown assets despite having lower expected returns. However, the reverse could also be true — if climate concerns were to lessen, the premium required by investors for brown stock risk should decrease, providing brown stocks with a tail wind.
Investors should also be aware that ex-ante, brown stocks have higher expected returns, both because of investors screening out brown stocks (leading to lower valuations and thus a higher cost of capital — and the flip side of a higher cost of capital is higher expected returns to investors) and because they are riskier (brown risks are already incorporated into prices), as they are more subject to tail risks due to climate events, changes in government regulation that can lead to stranded assets, and fraud due to poor governance and weaker controls.
Important Disclosure: For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. The analysis contained in this article is based upon third party information available at the time which may become outdated or otherwise superseded at any time without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of the Buckingham Strategic Wealth®, Buckingham Strategic Partners® (collectively Buckingham Wealth Partners). Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined that accuracy or adequacy of this article. LSR-21-186
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.
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