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Innovest Group
A recent study by Innovest Strategic Value Advisors, a New York-based financial advisory firm, found that utilities with above average environmental performance outperformed those with below-average performance by over 600 basis points during the previous year. The study confirms nearly 100 other studies which found a positive correlation between environmental and stock market performance, largely because environmental performance is an excellent proxy for management quality, a key determinate of stock returns.
In high impact sectors, rising environmental restrictions and consumer demands for more environmentally-responsible products, services and corporate policies, make the environment one of the most complex challenges facing management. If management can effectively address this level of complexity, it is implied they have the sophistication to succeed in other areas, and thereby earn superior returns.
Innovest’s study analyzed the growing environmental risks facing investors, market opportunities created
by these risks, and the widely varying management responses to rising risks and opportunities. In addition,
the company’s EcoValue ’21 environmental rating methodology was used to assign ratings intended to project stock market performance. Under deregulation, responsibility for environmental costs is being shifted from ratepayers to investors. As a result, investors face potentially large write-offs if rising environmental restrictions make some coal-fired power plants uneconomic. Under the Clean Air Act (CAA) of 1970, older "grandfathered" coal-fired power plants are often allowed to emit over four times as much as new coal plants.
As a result, these older facilities produce over 90% of the sector’s emissions. The sector, in turn, produces a
significant portion of US emissions (67% of SO2 and 28% of NOx). These contribute to the formation of acid
rain, smog and soot, which damage human health and the environment. The CAA requires that grandfathered plants meet new plant emission standards if they receive major renovations.
The Environmental Protection Agency’s lawsuit filed recentenly against seven electric utilities for violating
the Clean Air Act illustrates the growing environmentally-related risks facing investors and the importance of screening investments for environmental performance. The EPA lawsuit contends coal-fired power plants, owned by American Electric Power, Southern Company, Cinergy, First Energy, Illinois Power, Southern Indiana Gas & Electric and Tampa Electric, were not upgraded as required. The utilities plan to oppose the EPA lawsuit, saying they extended the lives of their older plants through routine maintenance, rather than major upgrades, and therefore did not violate the CAA. Regardless of the lawsuit outcome, utilities will face increasing pressure to limit air emissions. This, in turn, raises investor risk exposure. Given the large body of empirical evidence showing that companies with better environmental performance achieve superior stock market returns, more investors are realizing that using an environmental screen, such as EcoValue ’21, is a cost effective means of minimizing risk exposure and maximizing stock market returns.
