Should investors expect to earn high returns on sustainable investments? | Blog post


Investors often cite improved returns as one of the main motivations for applying ESG criteria, and investment managers often market sustainable investment products that offer superior returns.

Furthermore, over the last decade, environmentally friendly actions outperformed those at the opposite end of the environmental spectrum.

Of course, managers should caution clients that past performance is not necessarily predictive of future returns, and we think investors should heed that caveat when it comes to green assets.

Indeed, the gap between historical returns and what investors should expect is critical to our studio.

What does the theory say?

Investors should expect green assets to underperform brown assets, not outperform them. As we showed earlier (Pastor, Stambaugh, and Taylor, 2021), investors should expect green assets to have lower returns because:

• Many investors take satisfaction in feeling they are investing responsibly by allocating more green assets, while reducing or divesting their brown holdings. This relatively higher demand means that green assets are priced higher, implying lower expected returns.

• Green assets perform better than brown assets in the face of adverse weather news. These outperformance thus soften the blow of that news for holders of green assets. This hedging ability also drives investor preferences, again leading to higher prices and lower expected returns for green assets compared to brown ones.

What does practice show (data)?

The lower expected returns on green assets are more than just theoretical, as our analyzes of the data show.

We calculate the rate of return that equates the current price of an asset with the discounted stream of its future payments. For a bond, this rate of return is simply its yield to maturity. For a stock, we use its implicit cost of capital (ICC), since the expected return on the stock is not directly observable.

In both cases, this calculated rate of return corresponds to the future return on the asset that an investor should expect. We then compare these expected returns for green versus brown assets.

For bonds, as of 2020, the German government bond market has offered a clear comparison between green and non-green bonds, with the former consistently underperforming. In the case of stocks, green stocks consistently had lower ICCs than brown stocks over the previous decade, and their greenness was measured using MSCI environmental ratings.

Eliminate unexpected returns

We also look at what has driven realized returns, recognizing that what was expected may differ from what actually happened. Green stocks have outperformed over the past decade because their prices rose unexpectedly, relative to brown. The main driver of that outperformance was adverse weather news, as measured by Ardia et al. (2021).

During months when the mainstream media reported particularly negative weather news, green stocks significantly outperformed brown. In fact, if we remove those weather news shocks along with the windfall news, we find that green stocks would have underperformed brown stocks.

Figure 1 shows this result. The solid line shows a very positive realized return from a Green Minus Brown Portfolio (GMB), which is long green stocks and short brown stocks.

The dotted line shows a moderately negative counterfactual performance of the GMB portfolio, which we estimate would have occurred in the absence of weather and earnings shocks. The figure shows that actual performance substantially exceeded hypothetical performance.

The dashed line provides a better estimate of the expected performance of the GMB portfolio in the future than the solid line. The solid line is well above the 95% confidence interval for the counterfactual return, indicating that the return for green stocks relative to brown was significantly higher than expected.

Figure 1. Performance of GMB performed vs. hypothetical

Why bad weather news should lift green stock prices and lead to unexpected outperformance Rising Climate Concerns:

• can increase investors’ desire to own green assets; Y

• are likely to increase the expected future earnings of green companies and reduce the expected earnings of brown companies, for example by increasing expected sales of electric vehicles and increasing the likelihood of carbon taxes and regulations.

Value vs Growth

Our study also offers new insight into the contrasting styles of growth and value investing. For nearly a century, value stocks have outperformed growth stocks on average. Yet over the past decade, value stocks have vastly underperformed growth to an extent never before experienced.

This historical underperformance of value stocks can largely be attributed to the outperformance of green stocks versus brown stocks. Once we control for our green factor, the theoretically motivated difference between returns on green and brown stocks, 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.

Overall, our findings suggest that investors should not expect to outperform green assets in the future. Green assets have outperformed in the past, but this was driven by unexpected shocks that cannot be expected to repeat themselves in the future.

This blog is written by PRI staff members and invited contributors. Our goal is to contribute to the broader debate on current issues and to help showcase some of our research and other work that we do in support of our signatories. Note that while you can expect to find some posts here that largely concur with official PRI views, the blog’s authors write in their individual capacity and there is no “household view.” The views and opinions expressed in this blog also do not constitute financial or other professional advice. If you have any questions, please contact us at [email protected]


Ardia, David, Keven Bluteau, Kris Boudt, and Koen Inghelbrecht, 2021, Climate Change Concerns and the Performance of Green vs. Brown Stocks, Working Paper, National Bank of Belgium.

Pastor, Lubos, Robert F. Stambaugh, and Lucian A. Taylor, 2021, Sustainable Investing in Balance, Journal of Financial Economics 142, 550–571.

Pastor, Lubos, Robert F. Stambaugh, and Lucian A. Taylor, 2022, Dissecting green return, Journal of Financial Economics, forthcoming.

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