The financial performance of renewable energy stock indices: clean premium or dirt-free discount? Andreas G. F. Hoepner ab & Michael Rezec a* a School of Management, University of St. Andrews b Academic Fellow, United Nations Principles for Responsible Investment *Presenting Author 1

European Union Emissions Trading Scheme (EU ETS) 2

Background Carbon Emission Markets have grown substantially –In 2005, 717 Mt.Co2 of $10.9bn and 2009; 8,700 Mt.Co2 of $143.7bn –Annual trading growth rates between 60% and >200% > 70% took place on European Union Emissions Trading Scheme (EU ETS). Growth rate is expected to remain over next decade –Due to the start of the 3rd trading period of EU ETS ( ) Governments worldwide are pushing policies to produce low carbon economies As a result, the demand for renewable energies worldwide has risen significantly 3

Previous research on financial performance & investment style of Renewable Energy Indices (REI) Selected portfolios of renewable energy firms significantly perform better than their benchmark (Chia et. al, 2009) –Find a green factor in financial markets Eco-efficiency results in significantly positive performance in US stock market (Derwall et. al, 2005) Stock returns are negatively correlated to climate change corporate responses in countries with lax climate change policies and positively in countries with stringent policies (Ziegler et. al, 2009) Renewable energy mutual funds are not substantially better than matched conventional or socially responsible funds (Hoepner & Lehnen, 2011) 4

Research Questions (1)Is there a difference between the financial performance of renewable equity stock indices and their benchmark indices? (2a) Does the financial performance of renewable energy stock indices differ over time? (2b) Which investment styles are preferred by Renewable energy indices? (3) Does the financial performance of renewable energy stock indices depend on the investment region? 5

Data We use total returns of 11 alternative energy indices The sample period starts with the first index launch in January 2000 to May Indices have diverse geopraphic investment objectives: –Global –Europe –North America Carhart (1997) model variables from Style Research Ltd. based on Worldscope database Risk-free asset returns from Datastream 6

REI Eligibility criteria Environmental Sector Screening –Alternative Energy Technologies, such as natural gas, solar, wind, ethanol, geothermal etc. Environmental Income Screening –More than 50% of gross revenues/net income Liquidity Screening –Liquidity ratio, or –Trading volume & Market cap. 7

Financial performance and investment style Carhart (1997) model Our results (in Table 2) show: –No significant under-/over performances in any of the alternative indices –The sample shows significant exposure to small cap, growth & above average volatility Especially pronounced for Indices with global investment objectives –Momentum factor plays minor role in Index estimations (Schroeder, 2007) 8

Financial performance, investment style & back-testing Control for back-testing bias in renewable index returns: Our results (in Table 3) show: –Somewhat higher Adj. R-squared –2 out of 12 significant positive correlations between dummy and returns (Indicates better performance in the backtest period) –Controlling for backtest makes alpha coefficients more negative –European and Global green indices have similar investment style preferences Small cap, growth & volatile firms –European seem financially more attractive to investors (less negative alphas) 9

Financial performance, investment style & dummies Evaluate isolated financial performance & investment style : Our results (in Table 4) show: –In 2005 & 2006 no clear evidence of over/under- performance –In 2007, 10 indices significantly outperform –In subsequent years significant positive dummies are reversed (In 2009 & 2010) –Results indicate a performance shift in 2007! 10

We test the effects of crude oil shocks as follows: –Oil Variable is the logged difference of Brent Crude Oil in USD –Also, include a one-month lag Results (in Table 5) indicate: –Almost all except one coefficient are positively correlated. –This finding is intuitive given that a higher oil price should lead to an increase in REI returns. –Results of lagged oil variable are not significantly different 11 Financial performance, investment style, dummies & oil variables

Over-Allocation of CO2 permits –This caused the Carbon price to drop dramatically in 2006 and stayed close to zero during most of 2007 Coal, Gas & Oil industry controls –Including orthogonalised (cleaned) independent variables such as: MSCI Europe Oil, Gas & Fuel Index MSCI World Oil, Gas & Fuel Index S&P 500 Oil, Gas & Consumable Fuels FTSE-All Share Oil & Gas Regulations, Subsidies & Co2 Taxes Impact of Carbon Conferences 12 Planned Additional Tests

Conclusion (1) We find no significant financial performance differential of renewable equity stock indices compared to their benchmarks. European & Global renewable stock indices are significantly exposed to small cap, growth & volatile firms. –Intuitive given the age and objective of renewable energy firms. Back-testing indicates better performance during back- test period (More negative alphas) 13

Conclusion (2) European renewable indices seem financially more attractive (less negative alphas) We can somewhat confirm Ziegler et al.’s (2009) observations on green mutual funds –Portfolios of countries with very stringent climate policies such as in Europe perform financially better than portfolios of countries with lax climate policies such as in the US. (Table 4) We can also confidently conclude that oil shocks are not the responsible driver for the good performance of REI during

Conclusion (3) Highly significant positive dummies in 2007 could indicate that traders assumed a push in that year because of the second round of EU ETS in On a global level, there might also have been a shift due to climate change policies. 15

Thank you for your attention. 16