The Impact of Circular Economy on Public Equity. Understanding De-Risking Effect and Superior Risk-Adjusted Performance

By decoupling economic growth from the exploitation of virgin raw materials and environmental degradation, as well as by developing practices more resilient to the economic cycle, Circular Economy (CE) offers effective hedging of climate and environmental risks, shields financial actors from the risk of stranded values, generates fresh and non-speculative demand for investments and ensures persistent performance of businesses and portfolios. For Financial Services industry drivers of opportunity rely first on the reduction of financial assets to risk exposure, that we call de-risking effect, and ultimately on a better risk-return combination for circular asset classes. We tested these hypotheses building a sample of 249 European circular shares focused on manufacturing, construction, energy and oil & gas industries. The time period considered is 2013-2018. The main explanatory variable is the Circularity Score (CS), a brand-new indicator computed following the methodology adopted by Thomson Reuters for calculating ESG score and based on the selection of material variables pertinent to CE included in its database. The hypothesis of de-risking is tested considering measures at both total risk and systematic risk level. The hypothesis of better risk-return combinations is tested assuming both the absolute risk-adjusted performance, in terms of Sharpe Ratio, and the relative performance, assuming the Treynor Ratio. We found that securities which score a higher level of circularity confirm both hypothesis, nonetheless as considered standalone or included in the fully diversified portfolio. This paper provides the first insight to the development of a materiality based CS that measures the degree of circularity of a public stock and the evidence of a positive relation amongst the degree of circularity with de-risking and risk-adjusted performance in capital markets