Aug 24, 2020 ESG

ESG - Investing in the fourth dimension

Why there will probably be no way around ESG criteria such as environmental protection, social standards and good corporate governance in investment in future.

  • Sustainability adds a fourth dimension to the magic triangle of investment: return, liquidity and risk.
  • Legislative initiatives such as the EU action plan for sustainable financing provide an additional boost.
  • DWS already has a wide range of active and passive ESG funds, which is constantly being expanded.
4 minutes reading time

Between 2016 and 2018, global sustainable wealth increased by 16 percent to $31 trillion.*

Sustainability is changing the world - and investment is no exception. More and more people want to target their investments at shares and bonds from issuers that are committed to environmental and climate protection. Compliance with social standards and good corporate governance are also important to investors.

A survey among visitors to the DWS website shows that 48 percent of participants already invest part of their assets in sustainable investments such as ESG funds.

"What we are currently experiencing is not temporary hype, but rather a fundamental upheaval in the investment industry," says Petra Pflaum, chief investment strategist for responsible investment at DWS. "Sustainability turns the magic triangle of investment goals into a square."

The magic triangle of investment is becoming a square

In the classical approach, investors used three main objectives to define their investment strategy: return, liquidity, and risk. These three goals impact on each other, which is why they are often referred to as the "magic triangle of investment". If one goal is prioritised, this is usually at the expense of the other two goals.

Investors should therefore decide which of the three goals is most important to them and which goals they are willing to sacrifice in return. For example, investors who want to generate particularly high returns must take more risk and tie up their money for a long time. As a rule, high returns are only possible at the expense of the other two goals in the magic triangle: risk and liquidity. Similarly, if investors want to minimise risk, their chances of earning a return are reduced. And those whose primary interest is quick and flexible access their money must either accept higher risk or forego above-average return opportunities.

An investment strategy must take account of sustainability

Sustainability has now become an additional objective of increasing importance to investors. Many people want their money to be used for something useful - or at least to ensure that it is not invested in enterprises they consider unethical, such as weapons manufacture. This has made sustainability the fourth investment dimension.

"An investment strategy that ignores ESG criteria is neither complete nor up-to-date in its approach," says Pflaum.

Legal requirements generate tailwinds

Legislators have now also recognised how important the issue of sustainability is in investment. The European Union is planning a financial market regulation reform. The necessary revisions to the so-called Mifid-II guidelines are currently being prepared by the EU Commission and must then be approved by the EU Parliament and the EU Council. Observers estimate that the regulation could come into force at the end of 2021, if everything goes according to plan.

All providers of financial products would then have to disclose which sustainability criteria they apply. In addition, the EU would like to make it compulsory for investment advisors to ask their clients about their sustainability preferences.

ESG becomes mandatory in investment advice

In future, if clients answer "Yes" when asked by their advisors whether they would like sustainability criteria to be taken into account in their investment, then advisors must reflect this in their product proposals. Under the plan, if advisors nonetheless decide not to recommend an ESG investment, they must give a firm reason for this in the declaration of suitability, which must be presented to the customer before the transaction. This means that fund and exchange-traded fund (ETF) providers will have to launch even more products, which provide for certain minimum exclusions, for example, or pursue a clear ESG strategy.

"The EU strategy has the potential to provide a further strong boost to the topic of sustainable investment," says Pflaum. She believes DWS is well prepared: "In 2008, we were one of the first investment companies to sign the UN Principles for Responsible Investments, or PRI. Today we are one of the leading providers of sustainable mutual funds with around €70 billion of assets invested sustainably for our clients. In Germany, we are the market leader."

With around 30 active and passive mutual funds, DWS's ESG product range now covers large sections of the investment universe across all asset classes. In 2019 alone, 11 new ESG funds were launched. Many more are currently being planned.

ESG funds on equal footing in terms of returns

It’s important to note that sustainability and returns are by no means a contradiction in terms.

"Many studies conclude that ESG factors have a neutral to positive influence on the performance of investment products," says Pflaum.

So, the fourth investment dimension should not have a negative effect on the other factors in the magic square. In fact, the opposite is often the case. Sustainable investments can complement investors‘ objectives in terms of return, risk and liquidity with environmental, social and governance criteria. In the long run, this should pay off.

*Source: Global Sustainable Investment Alliance: 2018 Global Sustainable Investment Review

"An investment strategy that ignores ESG criteria is neither complete nor up-to-date in its approach."

Petra Pflaum, CIO for Responsible Investments

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