More and more people want to invest sustainably. But how does sustainable investing actually work? What are sustainable stocks and do investors have to forego returns for a clear conscience? Sustainable stocks are in vogue: According to studies, sustainable equity funds achieve better returns than their benchmark indices without sustainability criteria.
Many people naturally pay attention to sustainability in their daily life. They buy consciously, use organic products and do without textiles or toys that were made by children. They also boycott companies that disregard environmental standards. Investing money is now also possible with a clear conscience. Investors can choose from a growing range of sustainable stocks or equity funds. And sustainable doesn’t mean boring. Investors do not have to forego returns when investing sustainably. On the contrary: investing with a clear conscience pays off.
What is sustainability
There are many definitions of this term. One that many refer to dates back to 1987, when the United Nations World Commission on Environment and Development (“Brundtland Commission”), chaired by Norwegian Prime Minister Gro Harlem Brundtland, presented its report “Our Common Future”. The definition comes from this report: Sustainable development is “that corresponds to the needs of today’s generation without endangering the ability of future generations to meet their own needs and choose their lifestyle.”
Even this short definition makes it clear that sustainability not only has an ecological dimension, but also an economic, social and societal dimension.
What are sustainable stocks?
The ESG criteria have been established for defining what exactly sustainable stocks are. E stands for environmental, S for social and G for governance (good corporate governance). This is why the term ESG investing is often used synonymously with sustainable or socially responsible investing in the financial sector. MSCI ESG Research is the world’s largest provider of sustainability analyzes and ratings. “ESG investing takes environmental, social and governance factors into account alongside financial factors in the investment decision-making process,” says Remy Briand, Managing Director of MSCI ESG Research.
When evaluating investment opportunities, MSCI Research looks at the following criteria in detail, for example:
- Expansion of renewable energies and ecological technologies
- efficient use of energy and natural resources (raw materials, water)
- environmentally friendly production
- low emissions to air and water
- comprehensive climate change strategies
- Respect for human rights and workers’ rights, for example the prohibition of child and forced labor as well as the non-discrimination requirement
- high standards of occupational safety and health protection
- fair conditions in the workplace, adequate remuneration and training and further education opportunities
- Freedom of assembly and trade union
- Implementation of sustainability standards among suppliers
- Ethical corporate principles
- Prevention of corruption and bribery
- Anchoring sustainability management at board and supervisory board level
- Linking the remuneration of the Executive Board with the achievement of sustainability goals
- Transparent remuneration policy
The criteria show that this is by no means just about “green stocks”, such as the manufacturers of solar systems or wind turbines. Companies from other industries are also included – if they meet the criteria.
Sustainable investment funds have been around for more than 30 years. In the past, however, they were usually significantly more expensive and at the same time much less diversified than comparable funds without sustainability criteria. For the investor, this meant that his sustainable investment was usually much more risky and at the same time lower-yielding than other investment products.
But that has changed significantly with the increasing number of sustainable investment funds. The biennial Global Sustainable Investment Review reported at the beginning of 2018 in the five most important investment markets around the world of sustainable assets with a volume of 30.7 trillion US dollars. That means an increase of 34 percent compared to 2016. The market share of sustainable investments has grown in all regions except Europe. According to this, sustainable investing has made up a significant proportion of professionally managed wealth in every region – from 18 percent in Japan to 63 percent in Australia and New Zealand. “It is obvious that sustainable investment is a major force in global financial markets,” the report said.
From 2016 to 2018, sustainable investments grew the fastest in Japan, followed by Australia / New Zealand and Canada. These were also the three fastest growing regions in the two previous years. The three largest regions in terms of sustainable asset value were Europe, the United States and Japan. The growing supply means more choice for investors, which in turn enables broader diversification to reduce investment risk.
Which sustainable stock to buy?
If you want to invest sustainably, you don’t necessarily have to buy a fund or ETF. Investors can also select stocks themselves that meet general or their personal sustainability standards. To research sustainable stocks in 2020, you can take a look at sustainability indices.
For example in the new DAX50 ESG index of the German stock exchange: The index shows the price development of the 50 largest and most liquid stocks on the German market that are particularly sustainable based on ESG criteria. The basis for the selection are all stocks that are listed in the DAX, MDAX or TecDAX. Companies involved in the trade or production of weapons, tobacco, steam coal and nuclear energy are categorically excluded. According to the German stock exchange, the index is designed in such a way that a “sustainable German stock market index is created whose liquidity and risk-return properties are similar to those of the flagship DAX”.
Another sustainability index is the MSCI World Socially Responsible Index (SRI). The index bundles around 400 companies from the developed world that have the highest ESG ranking. An alternative with much stricter criteria is the natural share index. It has been providing guidance on green investments since 1997.
For beginners in particular, investments in sustainable equity funds or ETFs are recommended instead of individual stocks. In addition, investors can achieve a broad diversification of the investment capital even with smaller amounts and thus reduce the risk of loss.
Do sustainable stocks have better returns?
However, the desire for sustainability should not lead to losing sight of the essential criteria of an investment. Good news: investors who make sustainable investments no longer have to do without returns. The range of sustainable investment products is now so large that it includes high-yield stocks, funds and ETFs.
Because the selection of sustainable stocks has grown so large, the cluster risk has decreased. This occurs when investors only concentrate their investment capital on one or too few sectors or regions – for example on German solar stocks. If this sector then gets into economic turmoil, it has a devastating effect on the depot. Those who, on the other hand, spread their investment capital widely across different industries and countries will not be dragged into the abyss by a stumbling segment.
In addition: for companies that ignore sustainability criteria, generating high returns will become more and more difficult in the future. Because global challenges such as climate change or environmental pollution and destruction increase the pressure on politicians to change the framework conditions. Penalty taxes and bans could even deprive environmental offenders of the basis of their business. In contrast, sustainable companies are better positioned. They are prepared for these challenges and are therefore not threatened.
So nobody has to do without performance if they want to invest sustainably. The majority of around 2,000 studies and analyzes on the return on ESG investments have come to the conclusion: On average, ESG portfolios do not achieve any worse returns than conventional products. Many are even better.
The reason: Sustainable investments benefit from the shift in social awareness towards more global responsibility and climate protection. In addition, sustainable companies rarely have systemic or reputational risks in their business model. And that also applies to the ESG funds or ETFs that invest in these stocks.
Is this also currently noticeable in the Corona crisis?
The Scope Group rating agency evaluates investment funds and has found in a recent analysis that sustainable global, European and North American equity funds outperformed their respective market index in the first quarter of 2020. While global sustainable equity funds lost an average of 17.2 percent in the first quarter, the benchmark index MSCI World lost 18.9 percent. In Europe, the comparison was also in favor of the sustainable funds, they lost 20.7 percent, the MSCI Europe on the other hand 22.3 percent.