What a Company’s Emissions Tell Us About Its Expected Returns
Climate scientists have identified greenhouse gas (GHG) emissions as the largest contributor to global climate change.1 As a result, many investors are looking to reduce their emissions exposure through their portfolios and wondering if doing so would affect their investment experience. A new research paper from Dimensional delves into this subject by examining the relation between firm-level emissions and expected returns.
Before venturing into the empirical analysis, it is helpful to consider the theoretical channels through which a company’s emissions characteristics may impact its expected stock or bond returns. Valuation theory tells us that current market prices reflect aggregate investor expectations about future cash flows and the discount rates they apply to those cash flows. The discount rates are investors’ expected rates of return.
It is reasonable to expect that a firm’s environmental profile could impact its future cash flows and the discount rate, due to risks, opportunities, and preferences associated with sustainability considerations. For example, if aggregate investor preferences shift in favor of companies with lower emissions, this can increase the prices and decrease the expected returns of stocks and bonds issued by these companies.
Our study of the relation between emissions and expected returns covers US, developed ex US, and emerging markets stocks as well as US corporate bonds from 2009 to 2018. We examine firm-level emissions profiles through three metrics: emission intensity, emission level, and change in emission level.
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What a Company’s Emissions Tell Us About Its Expected Returns
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.
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