Markets are missing climate risk; that's an opportunity
New study of financial professionals shows deep pessimism
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(Mark Hulbert, author and longtime investment columnist, is the founder of the Hulbert Financial Digest; his Hulbert Ratings audits investment newsletter returns.)
CHAPEL HILL, N.C. (Callaway Climate Insights) — How good a job are the markets doing at pricing climate risks?
Many working on climate change mitigation insist that the markets do a very poor job. They harbor a deep distrust of the markets, pointing to the buoyant stock prices of companies whose business models can’t continue if we are to live up to the Paris climate accord. ExxonMobil (XOM), for example, is beating the market so far this year, gaining 44.1% versus 17.8% for the S&P 500. (Both returns include reinvested dividends.)
Surprisingly, however, according to a new survey, most finance professionals also agree with this bleak assessment. For every one of them who believes the asset markets are too concerned about climate risks, this new survey found that there are 18 who believe the markets are not paying enough attention to those risks.
This just-completed survey, titled “What do you think about climate finance?,” is slated to be published this November in the Journal of Financial Economics. It was conducted by Johannes Stroebel and Jeffrey Wurgler of New York University, who shared the survey’s findings with me.
The reason I found the survey’s results surprising: Many, if not most, finance professionals’ default belief is that the markets correctly set securities’ prices. Indeed, in some circles that belief is orthodoxy: Prices are set in equilibrium through the endless give and take of myriad buy and sell transactions. If all, or almost all, investors agreed that climate risks aren’t fully reflected in a company’s stock price, its stock price would have already declined.
Might it just be that this survey’s respondents aren’t representative of the market as a whole? I doubt that’s the sole cause of the survey’s lopsided results about the pricing of climate risks. To sample what financial professionals think, the professors reached out to more than 11,000 potential respondents — including nearly 7,000 graduates of the MBA program at NYU’s Stern School of Business, graduates of Stern’s undergraduate program who are working in finance, professors of the top 100 finance departments, and researchers at 17 public-sector institutions such as the various Federal Reserve banks, the IMF and the World Bank.
Another reason to doubt that the skewed results are unrepresentative: Even among respondents who rated their concern for the climate as “low,” three times as many believe the markets aren’t paying enough attention to those risks as think the markets are paying too much attention.
Clearly, according to the survey, the belief is very widespread among finance professionals that the markets are under-appreciating the magnitude of climate-related risks.
How can the market be so wrong?
Why, then, haven’t prices adjusted to their “correct” levels? Wurgler, in an interview, suggested that one reason might be the obstacles investors face in putting downward pressure on bad-for-climate stocks. On the one hand, it’s relatively straightforward to buy the stock of a green company — a solar company, for example — and therefore bid its price up to what’s deemed its proper level. This may help to explain the extraordinary performance last year of ETFs such as the Invesco Solar ETF (TAN), which gained 233.9% — the best return of any unlevered U.S. equity ETF.
On the other hand, it’s not as easy to bid downwards the stock prices of companies that are considered bad for the climate. The most obvious way to do that is to sell those stocks short, which many investors are unwilling to do. Absent short selling, the alternative is to simply avoid climate-unfriendly stocks, and that exerts no immediate downward pressure. Furthermore, as I’ve pointed out in previous columns, many allegedly climate-friendly mutual funds and ETFs nevertheless own stocks of fossil fuel companies and others thought to be paradigmatic examples of being bad for the climate.
Another reason the market may be doing such a poor job pricing climate risks, according to Wurgler: It’s difficult to know how the long term risks of climate change should impact a stock’s day-to-day performance. He pointed out that, in his and his co-author’s survey, the majority of respondents said that the biggest climate-related risk businesses face over the shorter-term (five years or less into the future) comes from actions regulators might take.
Assessing the likely behavior of regulators is an entirely different cost-benefit analysis than determining the extent and nature of the climate catastrophes that we face over the longer term.
Perhaps there’s a glass-half-full way of understanding what this new survey has found: If indeed the markets are failing to adequately account for climate risks, that in turn means the markets still have a big potential to effect change.
What’s it going to take for the markets to do that? A majority of respondents to this new survey said that, among various financial mechanisms to spur more climate-friendly behavior by corporations, “pressure from institutional investors is… the most powerful force for change.”