With the world looking to cut greenhouse gas emissions to curb climate change, Dimension Fund Advisors moved to examine how emissions tie into companies’ expected stock and bond returns.
The firm found that emission metrics including intensity, levels, and change in levels fail to provide “additional information about future profitability beyond what is contained in current profitability,” Dimensional researchers Wei Dai and Philipp Meyer-Brauns said in a paper this week.
“More importantly, there is little evidence that these emission metrics are reliably associated with the cross-sectional expected returns of stocks,” they wrote, after controlling for drivers such as “market capitalization, relative price, and profitability.”
The Dimensional researchers examined how companies’ greenhouse gas emissions related to their financials and expected stock and bond returns from 2009 to 2018 globally. Their analysis of U.S. corporate bonds similarly found “no compelling evidence supporting the issuers’ emission metrics as additional drivers of expected bond returns,” according to the paper.
While “plausible that the environmental profile of a firm could impact its expected cash flows,” the researchers wanted to understand whether “emissions can improve upon current profitability as a reliable proxy for future profitability.” They found that the “risks and opportunities associated with climate change are reflected in market prices and existing proxies for expected future cash flows.”
“Prices quickly incorporate information and reflect the aggregate expectations of market participants, including information about a company’s environment-related risks and opportunities,” Dai and Philipp Meyer-Brauns said. “Our results suggest that investors can pursue environmental goals without compromising sound investment principles.”
Dimensional Fund Advisors had $527 billion of asset under management at the end of September, according to its website. Founded in 1981, the Austin-based firm says on its website that it has “a long history of applying academic research to practical investing.”
As profitability tends to be “persistent” over time, and “current profitability is a reliable proxy for future profitability,” the Dimensional Fund researchers found it important to question whether emissions contained any additional information about next year’s profitability after controlling for this year’s profitability, according to their paper. Their works suggests “emission intensity, emission level, and change in emission level lose their explanatory power for future profitability,” and that companies’ emission metrics don’t contain reliable information about their expected stock or bond returns.