Sustainable investing is booming and a new approach should provide some clarity

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Sustainable investing is booming and a new approach should provide some clarity

Hubert Keller - Managing Partner

Hubert Keller

Managing Partner

Interview with Managing Partner of Lombard Odier, Hubert Keller in Tagesanzeiger, 6 July 2020 by Holger Alich

Green investing – investing money in a way that makes environmental sense – is becoming increasingly popular. So far, though, no one has come up with a consistent definition of what this is. There are hopes that more clarity will emerge from Brussels.

Sustainable investing - no other product category enjoys as much popularity among Swiss investors. Ten years or so ago the volume of such products and strategies was just CHF 32 billion, but according to the Swiss Sustainable Finance association it reached CHF 1.16 trillion last year.

Savers want to invest their money with a clear conscience. And the Swiss financial services industry has sniffed out a business worth billions

Savers want to invest their money with a clear conscience. And the Swiss financial services industry has sniffed out a business worth billions. But things aren’t quite that simple. Even for professionals, it’s not easy to answer the following question: "What exactly is ‘sustainable’ investing?" For instance, Hubert Keller, says: "Everyone talks about sustainability, but there’s no clear definition of what this means and no standard."

Swiss Sustainable Finance, an industry association, groups together eight different investment strategies under the umbrella term "sustainable". Most investors use the exclusion approach, under which certain companies and sectors, like arms and coal, are ruled out. The second main approach is where a fund provider takes ESG (environmental, social, and governance) criteria as well as financial data into account when selecting stocks.

"Before clients can find the right sustainable investment for them, they first have to be clear about what they want to achieve," says Sabine Döbeli, CEO of Swiss Sustainable Finance. Do they want to avoid particular sectors? Or do they want to help bring about change?

Ratings are supposed to help, but they often contradict each other…

A separate industry has emerged to help investors make their selection: providers like Sustainalytics, MSCI and rating agency Standard & Poor's issue ESG ratings that are intended to make stock selection easier. These ratings are often based on publicly available data, company surveys and individual interviews.

Since everyone is gathering the same information, you might think that the ratings would turn out to be roughly the same. But a study by Credit Suisse Research Institute shows that the classifications often contradict each other. The most prominent example is Tesla: MSCI rates the electric car manufacturer as the best automotive stock as far as sustainability is concerned. But for FTSE, another ratings provider, Tesla is the worst in the class. Sustainalytics gives it an average ranking. One of the reasons underlying the divergent assessments is that MSCI primarily looks at the low-CO2 cars Tesla makes, whereas FTSE focuses on the emissions produced by the company's factories.

Since everyone is gathering the same information, you might think that the ratings would turn out to be roughly the same… but a study… shows that the classifications often contradict each other

Despite this, many fund providers rely on such ratings to put together sustainable funds. There is also a whole series of stock indices for sustainable investing. One of the best known is the Dow Jones Global Sustainability Index. This applies the "best in class" principle; hence the index includes Toyota, and even integrated oil giant Total.

“These ratings tell you very little about how companies are positioned for the transition in climate policies required under the Paris Agreement”, Hubert Keller

Hubert Keller is not impressed by these ratings and indices. "These ratings tell you very little about how companies are positioned for the transition in climate policies required under the Paris Agreement," he notes. Avoiding steel manufacturers because steel production generates a lot of CO2 is no way to go about things, in his view. "In fact, the companies that are major emitters of CO2 but have a plan to fundamentally decarbonise their business model are the ones that have the potential to drive the transition to a net-zero emissions economy," he says. Lombard Odier has developed its own models to check whether a client portfolio is exacerbating the effects of climate change or if the client is compatible with the objectives set down in the Paris Agreement to limit the increase in temperature to two degrees.

In fact, the companies that are major emitters of CO2 but have a plan to fundamentally decarbonise their business model are the ones that have the potential to drive the transition to a net-zero emissions economy

Unclear ratings and a plethora of different sustainability strategies

Legislators have now got involved with the aim of creating greater clarity – but in Brussels, not in Berne. The European Union is working on a definition of which economic activities are considered sustainable and which are not. The end result is meant to be a consistent "taxonomy".

An activity will be counted as sustainable if it contributes to meeting six environmental objectives. These include, for example, limiting climate change, promoting the circular economy or the sustainable use of water. An economic activity that undermines one of these objectives counts as an exclusion criterion. One major bone of contention that is still outstanding is whether nuclear power should be treated as sustainable. France is in favour, while Germany is opposed.

European Union is working on a definition of which economic activities are considered sustainable and which are not… An activity will be counted as sustainable if it contributes to meeting six environmental objectives

Is sustainable investing worthwhile for savers?

"The taxonomy will probably become the standard for creating financial products for the EU," says Bruno Bischoff, Head of Sustainability at Credit Suisse. But as with ESG ratings, one drawback of the planned taxonomy is that it says nothing about whether a company is heading in the right direction. "The taxonomy is binary: either something is sustainable or it isn’t," comments Bischoff.

Still, the taxonomy should at least provide investors with guidance, for instance requiring funds to show the percentage of stocks they hold that do or do not meet the EU standard. "The EU taxonomy will become an important basis for environmental financial products, but there is still a long way to go until the data is available," notes Sabine Döbeli from Swiss Sustainable Finance.

The following question remains: is sustainable investing worthwhile for savers? Credit Suisse Research Institute reviewed a series of studies and came to an ambivalent conclusion: "We found virtually no compelling studies at all showing that ESG funds perform better over the longer term.” Of, course this also means that at least investing with a clear conscience does not penalise investors when it comes to performance. But keeping an overview of all the different approaches is bound to put a strain on investors' nerves.

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