• What Matters? — Some environmental issues that are the subject of popular focus — such as carbon dioxide emissions — do not appear to be statistically significant for global investors.  Moreover, many countries’ environmental “health” has moved in the opposite direction of their economic development i.e., more pollution and higher per capita GDP.
  • Environmental Flows versus Stocks — What matters more to wealth generation is how an economy uses flows of raw materials, rather than the country’s stocks of natural resources.  Many resource-rich countries have lower levels of per capita GDP than resource-poor states that efficiently transform raw materials into wealth.
  • Intangible Capital Drives Wealth Creation — Intangible capital, which includes measures of human, social and institutional capital, is the key driver of wealth creation.  The share of natural capital in total wealth is relatively large in poor countries, but levels of intangible capital are very high in rich economies.
  • Environmental and Governance Factors Both Matter — Environmental factors generate an
    R-squared of 0.20 with country equity valuations; governance factors generate an R-squared of 0.16.
Geraghty_Fig. 1. Env Issues Country Vals

Executive Summary

  • Pollution does not appear to be a factor in the valuation of a country’s debt or equity markets.  Water scarcity, the loss of biodiversity and climate change undoubtedly pose risks to economic growth, yet research shows little correlation to date between environmental issues and investment metrics.
  • Many countries’ environmental “health” has moved in the opposite direction of their economic development i.e., more pollution and higher per capita GDP.
  • A lot of resource-poor countries have higher levels of per capita GDP than resource-rich countries.  What matters more to wealth generation is how an economy uses flows of raw materials, rather than the stocks of natural resources within the country. 
  • “The Ecological Footprint,” which is calculated by the Global Footprint Network, is a unique measure of a country’s consumption of flows of natural resources.  It measures, in hectares per capita, the amount of biologically productive land and marine area required to produce all the resources a country consumes.
  • The Ecological Footprint — a measure of consumption of natural resources — can be compared to the amount of wealth generated within a country.  For 32 countries we calculate the amount of GDP per capita generated by each hectare of ecosystem services consumed per person.  There is a reasonably robust relationship (R-squared of 0.20) between (i) GDP per capita generated by each hectare of ecosystem services consumed per person and (ii) a country’s P/E multiple.
  • The implication is that a country which is quite efficient in transforming flows of ecosystem services into wealth is “rewarded” with a relatively high P/E multiple e.g., the Netherlands.  Conversely, a country that is resource rich — such as Russia — but that is inefficient in transforming its natural resources into wealth is assigned a relatively low P/E multiple.
  • It would seem that the efficiency with which natural resources are transformed into wealth is important to a country’s valuation primarily because it is an indicator of the social and institutional development of the country.

Please contact us on how you can become a client and read more about our analysis of Environmental Issues & Country Valuations: What Matters?

Michael Geraghty is the Global Markets Strategist at Cornerstone Capital Inc. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.