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Are sustainable investment strategies, in their current form, fit for purpose?

To answer this burning question, our trusted data partner, the Danish FinTech company Matter, decided to utilise their own tools and insights to conduct an analysis of the 50 largest UCITS sustainability-themed ETFs to see what really lies beneath.

Below is an excerpt of the white paper "A House Built on Sand".

(You can find a link to full document at the bottom of the article.)

Matter came to some rather interesting conclusions, but on a positive note, also to some rather clear recommendations for what needs to be done now to flip the switch.

Some of these include:

  • When investing in an ESG/SRI ETF, an investor would likely expect (at minimum) that it would be more sustainable than its non-sustainability-focussed parent index. In most cases, they do offer a more sustainable alternative. Unfortunately, the majority offer only marginal sustainability gains, and 10% of the ETFs analysed performed worse than the parent index.

  • On average, ESG/SRI ETFs expose investors to less than half the renewable energy generation of their parent indices, and only 2% of the renewable energy generation offered by thematic clean energy ETFs.

  • Huge fragmentation exists between similarly branded products and within individual sustainability themed ETFs. This fragmentation is not easily visible to investors, preventing the genuinely sustainable from standing out, and allowing greenwashing to hide in plain sight.

  • Before things start to change, the common understanding of sustainable finance needs to change. An excessive focus on ratings and financial materiality is still holding the industry back. New regulation is moving in the right direction, but the journey is long. Improved data is at the heart of a transparent, evidence-led approach to sustainable finance.

Although this research was based on the top 50 sustainability-themed ETFs, it is likely the findings can be carried across to other unitised investment products.

As an investor - what can be done?

When allocating funds towards sustainable investments, it would seem that the biggest indicator of impact is the strategy employed by the manager.

In the research, there were 3 predominant strategies employed, although it does mention that these strategies are becoming increasingly blended.

  • Best-in-class approaches select the most sustainable companies or leaders across sectors.

  • Exclusion-screening strategies eliminate the companies or industries that do not meet minimum standards of sustainability based on international norms.

  • General integration strategies factor ESG considerations into investment selection and decision-making processes to mitigate risks or enhance returns.

Best-In-Class approaches appear to produce more sustainable outcomes than its counterparts.

General Integration, which tends to only consider ESG factors, has come under fire, including in a Bloomberg News Article which claims that roughly $25 trillion out of $35 trillion in sustainable investment assets employ this strategy, and that this is “helping to create a false impression that the world of management is directing capital towards helping solve societal ills.” It also tallies with recent critiques from individuals like Tariq Fancy, who argues that the world of ‘ESG’ as it currently is amounts to little more than a game of smoke and mirrors.

While Best-In-Class ETFs offer a more sustainable option overall, the Matter whitepaper finds that Best-In-Class ETFs also figure among the worst performers compared to their peers and finds General Integration ETFs which outperform the majority of their peers.

The paper also draws an interesting correlation between labels of investment products and how they perform as a 'green' fund. This essentially comes down to the fact that products labelled with ESG is more likely to employ exclusion screening strategies, while funds with labels like Socially Responsible or SRI lean towards Best-in-Class strategies.

No alternative for granular, transparent data

Although there are detectable patterns, the research shows that each fund must be treated individually, as each fund exposes investors to very different outcomes. These tools must however be democratised if an evidence-led approach to sustainable finance is to become the norm. With better access to better insights and modern investment data management tools to help with the data aggregation, investment managers can navigate the field of sustainable finance with confidence, greenwashers can be exposed, existing sustainable opportunities can stand out and new ones can be more easily created. Crucially, it also enables regulation which sets more ambitious standards for investors and issuers.

To see how ICS approaches ESG and Sustainability data and reporting, see more here.

Download A House Built on Sand from Matter.


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