Jan 05, 2021 Sustainability

ESG investments: The four most important questions investors need answered

Sustainable investment products are booming. However, investors should be able to answer a few essential questions before investing in funds that promise long-term relevance for society and the environment.

  • Sustainable investing is in vogue - in 2019, the total amount invested in Germany was 18 billion euros.
  • Investors should look closely at the investment strategies of individual funds as company selection works differently.
  • If an investor wants to invest sustainably, there are now options available in almost every asset class.
6 minutes to read

More and more people are paying attention to sustainable lifestyles. They buy products that protect the environment, are organically grown or support society in the long term. What purposes or projects their investments finance is likewise becoming important for them. In 2019, private investors in Germany alone invested around 18 billion euros in sustainable investments - almost twice as much as in the previous year.[1]

Who decides to invest money in sustainable ways is now spoilt for choice, as the range of "green" and socially oriented financial products has increased dramatically. But answers to four essential questions provide investors with a valuable compass in the expanding jungle of sustainable financial investments.

How should availability, risk, return and sustainability be weighted?

Three mutually influencing aspects determine an investment strategy in classical terms. Next to the mere availability of a certain asset class, it is its yield and risk as well as the balance between the two. If, for example, an investor focuses particularly strongly on return, he or she usually has to take higher risk. If the focus is however on a rather safe financial investment, the return is usually reduced. For investors who value sustainability, there is now a fourth parameter to be considered when it comes to decide on an investment product.

The good news is that sustainability as an additional decision-making factor usually has no negative effect on the return or risk of an investment. On the contrary, a review by the University of Hamburg of around 2,000 studies looking into the topic shows that sustainable equity funds often perform better, or at least not worse, than their respective benchmarks.[2] And a study by rating provider Scope confirms this suggesting that, in contrast to traditional investments, sustainable investments can even be associated with lower risks as they typically undergo analyses of more in-depth aspects compared to classic investments. Hence it is about minimising risks while recognising additional opportunities that are disregarded in classical investment. Thus over a period of five years, the Scope study shows, sustainable funds not only generated similarly good returns, but they were also less susceptible to fluctuations.[3]

This means that since a sustainable investment does usually not negatively affect performance and can minimise risks, investors can give the topic of sustainability a particularly strong weighting.

Poll

How important is sustainability to you when it comes to investing?

From exclusion to best-in-class - how is sustainability measured?

What makes a fund a sustainable fund? This question is answered in different ways. Some funds completely exclude controversial sectors such as, for example, the arms or coal industries. But there are at least four other selection principles, which in practice are usually combined. For example, the exclusion approach can be paired with the so-called "best in class" approach. Here, after exclusion has been applied, the best companies in a sector are selected according to defined sustainability criteria. This always involves the three fundamental dimensions of sustainable management: ecological prudence (environment), social responsibility (social) and good corporate governance - the ESG triad.

In order to assess how sustainably a company operates, DWS has developed its own selection software. The ESG Engine uses data from five rating agencies specialising in different ESG criteria to create its own ESG ratings for individual companies or sectors. The resulting selection lists serve as a guiding basis for analysts and fund managers in their investment recommendations and decisions.

"When it comes to sustainability, it is important to look closely. Sometimes the first impression doesn't stand up to closer scrutiny."

Petra Pflaum, CIO for Responsible Investments

Petra Pflaum, CIO for Responsible Investments at DWS, advises fund managers to take a generally pragmatic approach: "Not every company passes the test of closer sustainability scrutiny at first glance. The balanced assessments of the ESG Engine help our fund managers to make more deeply justified decisions when selecting companies. “

ESG, SDG, SRI - which abbreviation stands for what?

If you delve further into the world of sustainable investing, you will quickly come across different abbreviations and standards. Besides ESG, SRI and SDG are among the most common. All three describe complementary approaches to sustainable investing, the details of which investors interested in sustainability should familiarise themselves with.

Funds investing in companies along ESG criteria usually award points for the fulfilment of individual criteria within the three areas of environment, society and corporate governance. They evaluate the sustainability agenda of companies more or less according to what sustainable measures have already been implemented. In other words, they tend to be backward-looking.

SDG is the abbreviation for Social Development Goals, the 17 sustainability goals adopted by the United Nations in 2016. They formulate social, economic and ecological goals to be achieved by 2030. More and more companies are aligning their operating and business models with the SDGs, which makes them increasingly assessable for sustainability-oriented investors. They can thus invest in social or environmental values and, in addition to return opportunities, also influence concrete societal progress.

Finally, the acronym SRI stands for Socially Responsible Investment, a financial investment that is considered socially responsible due to the nature of a company's business - but at even stricter sustainability levels. What the company produces or offers as a service is important as a criterion and usually individual aspects of ESG and SDG approaches are combined here.

Everything on green - can my whole portfolio be sustainable?

Finally, investors are faced with the question of how far the range of sustainable investments already extends. For those who are interested, a sustainable counterpart can now be found for most common asset classes. In 2019, equities, corporate bonds and public bonds did have the highest share. But at that time, seven percent of all sustainable investments were already invested in alternative assets such as commodities or real estate.[4]

The range of suitable financial products is thus available. And it is up to the individual investor to decide how important the issue of sustainability is to him or her personally when investing money - just like in the supermarket in front of the shelf.

DWS fund managers can draw on data from five different ESG rating agencies.

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1 . Source: https://fng-marktbericht.org/der-nachhaltige-anlagemarkt-deutschland-2/

2 . ESG & Corporate Financial Performance: Mapping the global landscape https://institutional.dws.com/content/_media/K15090_Academic_Insights_UK_EMEA_RZ_Online_151201_Final_(2).pdf.

3 . Source: https://www.scopeanalysis.com/ScopeAnalysisApi/api/downloadstudy?id=9e4c5c1d-d0e8-48fb-b5f8-8cca84b5a384

4 . Source: https://fng-marktbericht.org/der-nachhaltige-anlagemarkt-deutschland-2/#investment

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