Robin, is sustainable investing something that’s been hyped up or will it last?
In our opinion sustainability is definitely not a hype. It is a topic that affects us all in our daily lives and in investing, too. And it's not just about the climate.
It’s true that sustainability starts with environmental issues such as biodiversity or climate change, but it also includes animal welfare, nutrition and product safety, and also extends much further than that, to issues such as respect for human rights or corporate behaviour with regard to working conditions, corruption or competition. All of this comes under the heading of sustainability, or ESG, Environmental, Social, Governance, for short.
But is this new? And why is it important for me as an investor?
ESG-specific criteria can have a direct influence on the future financial results of countries and companies. Traditional financial market models do not always sufficiently take this into account. With the additional consideration of sustainability factors, you can get a 360-degree view of an investment.
What are the benefits of such a 360-degree view?
Portfolio managers use a number of fundamental indicators to gain insight into the opportunities and risks of a company – for example, sales or profitability indicators. This data is like the tip of an iceberg: it is visible above the surface.
And like an iceberg, there is a much larger part that is not directly visible. This is the so-called non-financial information, the ESG-related data, which can provide additional valuable insights into the economic perspective.
You believe that investors should not invest responsibly out of goodwill alone but that their focus should also be about minimising risk. What risks can sustainability aim to reduce?
Through ESG-related data, we might be able to see how sustainably a company or a country is positioned. It's about answers to questions like: What is the climate strategy? How are energy, water and other resources handled? Are there risks due to the location or due to the transition to a low-carbon economy – so-called transition risks? Are there warning signs in terms of corporate governance?
The link between risk and performance may not be immediately apparent when considering social factors or corporate governance as part of ESG. But there is a wide range of evidence for it.
Does this mean that if a company does not act in an environmentally friendly way, it can be bad for its financial prospects?
Here's another example: in 2019, the dam of a retention basin broke on the site of a Brazilian iron ore mine, triggering a massive mudslide. More than 250 people died, and there was also property and environmental damage.
The mining company that owned the mine had already experienced a dam failure once before. Nevertheless, the company's management had apparently done nothing to prevent another incident. The company suffered a financial loss, with its share price losing a fifth of its value within a day. Added to this was the damage to its reputation and a whole series of legal proceedings.
You can see that all of these factors can have enormous financial implications for investors. And that's why it's important to use ESG information to take an in-depth look at a company's risks and opportunities. With the sustainability approach, you could possibly make better decisions. As an investor, I want to know how sustainable my investment is.
As an investor, I also want to know what products I'm getting. And there are a lot of terms in connection with sustainable investments? They are almost like secret codes.
That's true. The different terms don't make it any easier to find your way through the sustainability jungle. We at DWS have made a video series to explain the basics. And our DWS website offers a lot of information on the topic.
The right information is a key factor, not least when it comes to responsible investments. However, the same rule applies: even with responsible investing, a potentially higher return is always associated with a higher risk.
An important topic is performance. Doesn't the additional cost of sustainability stand in the way of an increase in value?
There are now quite a number of studies that demonstrate that integrating ESG factors across all major asset classes can add value and potentially improve the risk-return profile of a portfolio. Investment professionals are looking at much more corporate data and drawing conclusions from it.Eighty-eight percent of sources studied show that sustainable companies have better operating performance, which can translate into higher profit margins of up to 12.4 percentage points. Also of interest: in the Covid-19 pandemic, sustainable indices performed at similar levels or even better than their non-sustainable counterparts.
Index performance: sustainability vs. standard: world
MSCI World Index: includes 1603 large- and mid-cap stocks from 23 industrialized countries; All MSCI SRI Leaders indices are based on their respective parent indices. In contrast, they represent the exposure of companies with excellent ratings on ESG factors and exclude companies whose products have negative social or environmental impacts.
Sustainable indices compared to their non-sustainable counterparts: U.S.
Index performance - sustainability vs standard: U.S.
MSCI USA Index: includes 618 large- and mid-cap stocks from the U.S. market. All MSCI SRI Leaders indices are based on their respective parent indices. In contrast, they represent the exposure of companies with excellent ratings on ESG factors and exclude companies whose products have negative social or environmental impacts.
Sustainable indices compared to their non-sustainable counterparts: Europe
Index performance - sustainability vs standard: Europe
MSCI Europe Index: includes 435 large- and mid-cap stocks from15 industrialized countries in Europe. All MSCI SRI Leaders indices are based on their respective parent indices. In contrast, they represent the exposure of companies with excellent ratings on ESG factors and exclude companies whose products have negative social or environmental impacts.
Sustainable indices compared to their non-sustainable counterparts: Japan
Index performance - sustainability vs standard: Japan
MSCI Japan Index: includes 320 large- and mid-cap stocks from the Japanese market. All MSCI SRI Leaders indices are based on their respective parent indices. In contrast, they represent the exposure of companies with excellent ratings on ESG factors and exclude companies whose products have negative social or environmental impacts.
Sustainable indices compared to their non-sustainable counterparts: Emerging Markets
Index performance - sustainability vs standard: Emerging Markets
MSCI Emerging Markets Index: includes 1392 large- and mid-cap stocks from 26 emerging markets. All MSCI SRI Leaders indices are based on their respective parent indices. In contrast, they represent the exposure of companies with excellent ratings on ESG factors and exclude companies whose products have negative social or environmental impacts.
But how do you find the companies that are truly sustainable?
There are different valuation strategies for sustainable investing. It starts with simple exclusion criteria that sort out critical sectors or companies from an ESG point of view. Then there are value-based or standards-based selection processes that check the extent to which companies comply with international standards. It can go all the way to investing in issues related exclusively to sustainability.
And there is the best-in-class approach. This is not without controversy. Here, the companies selected in each sector are those that perform best according to ESG criteria compared to their competitors. The focus is not on whether what they produce or offer is actually sustainable. It is enough that they operate more sustainably than their competitors.
Best-in-class advocates believe this approach helps bring sustainability thinking to industries that some might not associate with sustainability, such as mining or oil production. The logic of the proponents: competition for improvement is triggered throughout the industry. Critics of the approach, on the other hand, argue that it merely gives a green coat of paint to the most sustainable companies in an industry that is unsustainable overall.
In our opinion the best-in-class approach should therefore be combined with minimum standards or simple exclusion criteria for ESG-dedicated products to avoid the impression of "greenwashing."
What can I do to invest in a truly responsible way?
One problem with sustainable investing is that so far there are no uniform standards for measuring the ESG performance of companies. There have been various initiatives to address this for some time. But it's not an easy task because the very different aspects of sustainability have to be included.
It makes sense for investors to research the fund prospectus or ask their advisor why a fund calls itself sustainable. What criteria and standards are actually used as a basis? Are the objectives and investment criteria presented clearly and consistently? Is the evaluation used to select the companies in a fund based on multiple data sources? If the answers remain vague, it is usually better to look for an alternative.
Speaking of which, what role does sustainability play at DWS?
It’s perhaps unsurprising that I say this, but for DWS sustainability is more than a trend. Sustainability is part of our DNA. We actively participated in shareholder meetings more than 20 years ago and since then we have continuously expanded our corporate governance guidelines, we have underpinned our sustainability approach with sound data management, we have integrated ESG criteria into our strategic market assessment and we have continuously expanded our product range. Today, DWS offers ESG products in all investment segments – active, passive and alternative investments.
And DWS is also active as a representative of its investors. We expect companies in which we invest on behalf of our customers to take sustainability seriously. If there is no noticeable progress with companies that need to catch up after multiple discussions – so-called engagements – then we may choose to exclude them from our investment universe.
We also see it as our mission to pave the way to a CO2-free economy. DWS is a member of the "Net Zero Emission Goal" initiative of the Institutional Investors Group on Climate Change (IIGCC). This commits us to climate neutrality in line with the Paris Climate Agreement. Of course, this won't happen overnight. The important thing, I think, is for a company to set out on this path. Admittedly, it's not easy. But in my opinion, it has to be done.