Two types of performance promised by sustainable investments
Whereas the success or failure of conventional investments is generally measured on the basis of financial performance indicators such as Alpha, Beta and Sharpe ratio, sustainable investments promise two types of performance: not only do they aim to generate a competitive return that is as good as that of their conventional counterparts, but they also aim to contribute to meeting important climate and sustainability goals.
The issue of competitive returns has been the subject of heated debate for some time now. On one side of the debate were portfolio theorists keen to point out that the use of exclusion and positive criteria reduces the investment universe, detracts from diversification potential and therefore inevitably results in a poorer risk-return ratio. However, proponents of the use of sustainability criteria firmly believe that the additional criteria applied to the sustainability quality of issuers help them to better understand their risks and opportunities and take them into account in their investment decisions. In their opinion, this information offsets the disadvantage resulting from a reduced investment universe. They also point out that the “improvement in quality through exclusion” concept is not wholly unknown in the capital market, for example it is used to define quality limits such as the “BBB” for bond investments.
A large number of empirical studies1 and many years of practical experience show that, as things stand, sustainable investment not only precludes a systematic disadvantage for risk and return, but even allows for risk-adjusted additional income.
Joachim Wuermeling, Board member of the Deutsche Bundesbank and thus cleared of any suspicion associated with protecting this form of investment from a marketing perspective, states: “Studies show that sustainable investments can deliver particularly strong risk-adjusted returns. This type of investment is therefore not only based on an ethical-moral imperative, but also serves one’s own economic interests.”2
However, whether these benefits materialise depends not least on the specific competence of the asset managers.
Although this substantially clarifies the question of financial performance, the question of the sustainability-related benefits of sustainable investment has only recently been addressed. Given the importance of these effects for sustainability-oriented investors, it is striking that they have taken so long to request in earnest on the provision of appropriate evidence regarding those benefits. This is changing now, not least because the regulator, for example of institutions for occupational retirement provision (IORP), is calling for relevant appropriate evidence3.
In particular, special attention is currently being paid to the carbon footprint of portfolios. The carbon footprint gives investors an idea of the environmental impact of their portfolios. The CO2 emissions emitted by companies listed in a portfolio are recorded and then allocated to the portfolio based on each company’s share of emissions. By way of a benchmark comparison, it then shows what the portfolio’s environmental impact is. As part of its Action Plan on Financing Sustainable Growth, the EU Commission has announced that it will develop specific benchmark indices that are specifically suited to such a comparison4. One of the indices will show whether a portfolio is compatible with the stated objective of the Paris Agreement of limiting an increase in global temperature to a maximum of 2 degrees.
By using the UN Sustainable Development Goals (SDGs) as a basis, initial investors are extending their sustainabilityrelated impact analysis beyond climate change to 16 additional sustainability goals5. They are interested in knowing the contribution made by the companies whose stocks and bonds they add to their portfolios to achieving these global sustainability goals. With this in mind, they analyse the product and service portfolio of companies and measure the share in turnover generated by products and services that contribute to the achievement of the UN SDGs. The higher this share across all companies in a portfolio, the greater the sustainability-related impact.
The carbon footprint and SDG mapping are, in any event, initial attempts aimed at partially satisfying the legitimate interest of sustainability-oriented investors in obtaining information on the second type of performance promised by sustainable investments. However, these instruments have not yet been fully developed and cannot yet be used globally. For instance, SDG mapping can, strictly speaking, only be used in companies and, as regards the carbon footprint, the analysis works best in all-equity portfolios. Further improvements and new approaches to measuring the impact can be expected over the coming years.
ROLF D. HÄSSLER
Rolf has more than 20 years of experience in the fields of sustainability
(1) https://www.ussif.org/performance (2) Zentralbanken müssen grüner werden, die Zeit, 12/06/2017, https://www.zeit.de/2017/51/nachhaltigkeit-investitionenzentralbanken-klimaabkommen (3) https://www.pensionseurope.eu/iorp-iidirective (4) Commission action plan on financing sustainable growth - 03/08/2018
- https://ec.europa.eu/info/publications/180308-action-plan-sustainable-growth_en (5) https://www.un.org/sustainabledevelopment/sustainable-development-goals/