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Green investments—or those made in environmentally friendly stocks and bonds—have outperformed others over the past decade.


Should investors expect that trend to continue into the future?


Probably not. 


That’s the key finding of the research awarded the 2022 Moskowitz Prize by the Kellogg School of Management. The Prize, awarded annually, is the premier global recognition for research in sustainable finance. A panel of expert judges choose a high-impact paper focused on sustainable, responsible investing with the potential to influence practice. 


The Moskowitz Prize recipients are Lubos Pastor (University of Chicago Booth School of Business), Robert Stambaugh (The Wharton School), and Lucian Taylor (The Wharton School), for their paperDissecting Green Returns.” The research was selected from over 160 total submissions from diverse collaborators worldwide.The inaugural Moskowitz Prize, named after pioneering sustainable-finance researcher Milton Moskowitz (1932-2019), was awarded in 1996. 


Lucian Taylor, Robert Stambaugh, Lubos Pastor (from L to R)
Lucian Taylor, Robert Stambaugh and Lubos Pastor (L to R)

Lloyd Kurtz, head of social impact investing at Wells Fargo Private Wealth Management and currently visiting scholar at the Kellogg School, came up with the idea for the prize nearly three decades ago while working as a financial analyst. At the time, he believed there weren’t sufficient empirical studies to understand sustainable investing’s scope, impact, and dynamics. This led him to create the Moskowitz Prize to better publicize and incentivize sustainable finance research.


“In the early days of responsible investing we simply had no data,” Kurtz says. “And having no data means no good analysis, which can lead to irresponsible claims. By picking out a really strong study every year we’re building a body of knowledge to bring clarity to critical questions about sustainability.”


Kurtz is again among this year’s Moskowitz Prize judges, a group of 15 distinguished individuals that includes Kellogg Dean Francesca Cornelli and Kellogg faculty members Ravi Jagannathan and Dave Chen. Kellogg received sponsorship support for the Prize from six financial institutions, including premier sponsors Bailard, the Calvert Institute for Responsible Investing, and Wells Fargo..


Understanding expected returns of green assets 


Many investors believe that applying ESG criteria to investments yields improved returns, and investment managers are quick to reinforce this. Indeed, in the last 10 years environmentally friendly stocks (green assets) have outperformed others (brown assets), lending further support to the argument. But do those beliefs and recent return trends mean environmentally friendly companies are actually more likely to generate a higher return in the future?


This is the question that the Prize-winning researchers set out to answer by assessing the factors that drive returns for green assets. 

Previous research conducted by the Prize-winners showed that investors derive satisfaction from owning responsible investments which can drive prices higher and the expected rate of return lower. “If some investors in the market get what we call a ‘warm glow from holding green assets, the expected returns on ESG-friendly assets should be lower, not higher,” Stambaugh says. Moreover, investors pay higher prices for assets that hedge against climate risk.


Were expected returns for green stocks lower than they were for brown stocks in the study period? The researchers examined green and non-green bonds issued by the German government in the 2020s as well as the implied cost of capital for green and brown stocks (categorized based on MSCI environmental ratings) in the 2010s. Their assessment did, in fact, find a “greeniumconsistent with theory. In other words, the authors found that investors paid a premium for future cash flows from green assets and that they expected lower returns on the investment compared to brown assets.


Why, then, did green assets have higher realized returns in the study period? The researchers looked at factors that could account for differences in expected versus realized returns and discovered that unexpected adverse climate news explained why green assets delivered higher returns in the study period. When they removed the impact of such news and unanticipated earnings, green stocks would have underperformed brown stocks as predicted.


It turns out over the past decade, we've had a run of surprises of bad climate news,” Pastor says. “And that propelled green stocks up relative to brown. Once you remove this unexpected component, you don't see any outperformance of green assets anymore.”The findings also help explain why growth stocks strongly outperformed value stocks in the last decade, reversing a century-long trend. The Prize-winners suggest this outperformance can be explained by the high return on green stocks (mostly growth stocks) that was driven by climate news. Once climate-concern shocks are accounted for, the recent gap between growth and value stocks largely disappears.


In general, the team’s findings suggest that the outperformance of green versus brown stocks should not be expected to continue, because it was driven by unexpected news. In other words, their findings indicate that investors should retain the assumption that green stocks will have lower expected returns in the future. 


That’s not necessarily bad news, as Taylor notes: “We show that greener companies have lower cost of capital than brown companies. So that's good news for ESG investors who are interested in making capital cheaper for environmentally friendly companies or making capital more expensive for dirtier companies.”


What the judges say


“The researchers show that global markets today are pricing in the environmental risks in a way that historically had not occurred,” Kurtz says. Pricing of these securities now reflects a green factor. If it's green, then the person selling the stock, the company who wants to raise capital in capital markets, is going to get more money for a given price, or it's going to get capital at a lower cost than it would in other circumstances. And the investor is bearing the cost of thatthat’s a really important finding.”


“The mission of the Moskowitz Prize is to separate the reality of sustainable investing from fanfare, and this paper is an important contribution to that effort. The researchers take an important puzzle of sustainable finance – the recent outperformance of green stocks - and offer a compelling explanation,” says Megan Kashner, the director of social impact and lecturer at Kellogg.


A meaningful award


The Moskowitz Prize, now nearing the end of its third decade, represents an important award on the broad sustainable finance landscape.

“We’ve long known of this prize, even well before it went to Northwestern,” Stambaugh says. “And we know it’s a highly prestigious award recognizing research on sustainable investing. So we’re very honored to receive it.”


Kurtz, who originated the Moskowitz Prize, notes how it has sustained relevance over time: “It has been a gradual shift over a quarter century, but I think people now are understanding that ESG is never going to go away. We can think of ESG as a societal conflict resolution mechanism. Government can't do it all, markets can't do it all.


He continues, Some issues kind of fall through the cracks, and climate change is a great example, where private enterprise is supposed to maximize profits and government is supposed to regulate. But that can create a menacing environmental situation related to carbon risks in the long term. ESG and the research that supports it addresses this issue. That’s what we want to recognize with the Prize. That’s why the world needs it more than ever, to find the big studies in this space that are really well done.