Flash of green: are environmentally driven stock returns sustainable?

Purpose The purpose of this paper is to explore the source of apparent abnormal returns accrued by “green” company stocks. Though one cannot completely rule out that market-to-book and size factors may already capture the information of Trucosts’ total damage measure, the authors attempt to attribute the effect to risk, a persistent desirable characteristic or a short-run attention effect. Design/methodology/approach The authors construct portfolios of stocks using the Trucost data for identifying more environmentally friendly companies. The authors then compare the risk-adjusted returns of the green portfolios to the non-green portfolios. A secondary analysis of the price impact of being listed on the Newsweek green company listed is used to determine attention effects. Findings The authors find that green stock returns outperform the most polluting stocks by 3.7 percent per year on a risk-adjusted basis. The evidence is most consistent with a significant but economically small attention effect coupled with a longer lasting and greater magnitude desirable characteristic driving green returns. The authors do not find evidence of a risk-contribution to the performance after controlling for well-known factors. Practical implications Fund managers may benefit from this research in selecting green stocks, and thereby enhancing investment performance, with desirable characteristics without fear of increasing risk. Social implications One social implication is that investing in sustainable and green firms may not only be beneficial for the common good but also for the investor. Increased capital flows, and hence lower borrowing costs, for green firms may assist in creating a more ecologically sustainable economy. Originality/value To the authors’ knowledge this paper unique in attempting to determine if the green premium is a short-run inefficiency resolved by attention or a result of a desirable characteristic.