Innovest Strategic Value Advisors

The Performance Impact of an Environmental Screen

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Courtesy of Innovest Strategic Value Advisors

In the past, environmental screens have been viewed as unprofitable by investors and portfolio managers, primarily due to the belief that they underperform the market. The results of this backtest refute these misconceptions by indicating that environmentally responsible companies do not trail the averages, and will in fact become increasingly attractive investments the importance of environmental performance grows.

HYPOTHESIS:

A portfolio of environmentally responsible companies will underperform a portfolio of companies rejected by the same environmental performance screen.

METHODOLOGY:

A back-test of stocks over twenty-two years, used to compare the stock performance of a portfolio of companies that passed an environmental screen with the performance of companies that failed the same screen.
The study’s universe was the S&P 500 as defined at the beginning of each year, from 1971 through 1993. S&P 500 stocks were annually divided into two portfolios, one comprised of stocks that passed an environmental screen and the other of stocks excluded by the screen. The screen eliminated any company that emitted more than 1 million pounds of pollutants yearly, had a history of environmental fines and enforcement actions exceeding its industry group, was a potentially responsible party at three or more Superfund sites, or had a business primarily based on nuclear power generation. In order to apply the screen objectively, the study did not account for individual company improvement over time; i.e., if a company did not pass the screen at any time over the backtest period, it remained excluded from the “pass” portfolio. Performance was measured on equal-weighted portfolios screened each year. On average, the “pass” group included approximately twice as many companies as the “failed” group. Therefore each company in the “pass” portfolio was given about half the weight of those that failed the screening.

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