Updated: Feb 6
Disclaimer: This article illustrates my personal view on this subject. It does not in any way contain recommendations for investing money.
There are several ways to invest sustainably. Just as everyone has their risk tolerance, everyone needs to define with what they mean by 'sustainable' or 'green'.
Sustainable jargon is omnipresent: 'ESG' or 'SRI' does not automatically mean green investing or investing sustainably. ESG labels and denominations do not guarantee that the product will be as sustainable as stated on it.
As a country, Luxembourg still needs a lot of air to position itself as a sustainable leader. As the second largest fund domiciliary in the world, Luxembourg holds all the levers in its hands.
Would you invest in real estate? Or would you rather be in a stock or a bond? Or rather in gold, or maybe even in Bitcoin? Or should your money rather sit on your account? And, how do you invest sustainably?
Many people may not feel affected by this subject at first glance. And yet every citizen is somehow confronted with the question of whether and how one manages a certain portion of his wealth. Whether it is to save, to actively manage or indirectly as a result of legal obligations (e.g. pension fund).
There are many possibilities, but often only limited options. Therefore, I turn to one of the subjects more specifically: sustainable investment.
Sustainable investing ... what is it?
55% of people do not know that a sustainable approach to saving or investing is possible at all. So, you are not alone when you ask yourself: Sustainable investing ... what is it anyway?
I illustrate my understanding of 'sustainable' or 'green' investing using the chart below. There are several levels:
There are investors who are only interested in the financial return of their porfolio. Sustainable criteria are not included in the decision-making process.
There are investors who include environmental, social and governance (ESG) factors in their analysis. However, they will only opt decide as a result of those criteria only if they pose a risk to the financial performance of the portfolio.
There are investors who, by default, exclude various polluting or controversial industries from their selection. These could be fossil fuels from a climate point of view, but also other industries such as tobacco, alcohol, pornography, gambling, weapons, chemicals, animal violence, etc.
There are investors who pursue a “best-in-class” strategy. They invest in companies that are the best in their industry based on various ESG criteria. This approach is also often combined with point 3., however, it is not a guarantee that the manager will automatically invest in sustainable solutions. For example, the "usual suspects" Inditex (parent company in particular from Zara), Amazon, Facebook or Microsoft are often found in these buckets, because they have a "better" sustainable performance than their competitors. Approaches 2, 3 and 4 are also sufficient to give themselves an 'ESG' stamp.
There are investors who invest thematically only in socially and environmentally friendly companies. In contrast to point 4. only sectors or companies that make a positive contribution to sustainable criteria are considered, for example renewable energies or sustainable food. This approach is also often associated with Impact Investing.
Finally, there is the Philanthropy section, where financial performance comes last.
Source: own illustration inspired by various online sources. The graph does NOT mean that there is less financial performance from left to right. It's just a categorization.
How to invest sustainably?
A first, important step is that everyone needs to define for themselves what 'sustainable' or 'green' should mean in relation to their investments. Simply put: is it enough if you are only in a "best-in-class" or in an "ESG" fund or stock? Or do you want to invest exclusively in tomorrow's climate-relevant or green solutions?
Finally, we must not forget that investing should primarily generate performance and that a risk-return assessment therefore must remain a decision criteria. Everyone has a certain risk tolerance that needs to be articulated and in terms of which one should invest.
The essential question is: how much money are you willing to lose in a worst-case scenario in order to have a certain return in the long run? These are the famous MIFID questionnaires that every person must fill out before opening a deposit account. Here you will find out how much you can invest in which asset class, for example what % in equities or what % in bonds.
Once you have figured out for yourself what your financial and sustainable preferences are now, the question naturally arises: how can you now sustainably invest my money as a function of these preferences? For the private individual, there is often nothing left but to turn to their bank.
Retail banks then often offers funds that have a certain denomination [ESG, Best-In-Class, Climate Transition, Sustainable Future ... you name it], to position the fund as sustainable, or shares recommendations for direct investments in bonds or stocks that have a certain position in the sustainable spectrum.
What do my banks offer?
Luxembourgish banks offer their clients a whole range of funds, whether managed by themselves or by external managers. Unfortunately, only a minority of these funds promote ESG criteria actively in the decision-making process.
This is because conventional fund management also relies heavily on diversification to minimize risk and maximize profits. Controversial sectors, in particular energy, often play a significant role in classical financial analysis.
At the same time, however, there are already a number of papers that prove that “ESG” funds do not perform worse, if not even better, than pure profit-oriented funds. Furthermore, the analysis of ESG factors also reduces the risk of the portfolio.
I also want to share a few examples that make me optimistic, without wanting to advertise for a bank.
BCEE [or: BCEE Asset Management] has recently issued two funds: “Bond Green” and “Equity Green”. The Bond Green Fund wants to offer clients the opportunity to invest in climate change that is “green” according to Bloomberg and / or the Climate Bonds Initiative. For the Green Equity Fund, the approach is that it should not invest in certain sectors (excluding fossil fuels in particular, but also tobacco, alcohol or lotteries) or invest in companies that have a commitment aligned with the 2°C objectives.
Banque de Luxembourg [or: Banque de Luxembourg Investments] has the “Sustainable Horizon” fund, which incorporates a number of sustainable criteria into the decision. For example, the fund has less CO2-intensive companies or companies with less social conflicts in their portfolio than the reference [the benchmark]. However, it remains a fund that invests primarily in large or medium-sized companies, such as Unilever, Danone or Kimberly Clark - it “only” selects those companies, with the relatively better ESG performance.
BGL can access a wider range of funds, as these are managed by the parent company BNP Paribas. There is a wide range of funds that are managed sustainably, in particular on the topics of climate change, water, food or health.
Other Luxembourg banks rely on the expertise of external managers. BIL also offers a wide range of ESG and thematic funds, even if these funds are not managed internally. The thematic funds support issues such as climate change, sustainable food or water. Raiffeisen works with Vontobel to determine their ESG approach.
The issue remains how each individual defines itself as 'sustainable' or 'green' - and whether the bank has the same understanding of this definition.
Do I have an assurance that the products or funds are really sustainable?
Luxflag analyzes funds for sustainability and, according to its press release of September 2020, labeled 303 funds. Of these, 236 are ESG, 34 in microfinance, 21 in green bonds, 7 in environment and 5 in climate.
Graph: own illustration - Infosource: Luxflag
Each label is always only as good as its definition. If your banker tells you that the fund is Luxflag labeled, then you have to ask yourself what label is meant. The ESG label only looks at whether the fund focuses on the integration of environmental, social and governance factors into the investment process, in order to make informed decisions. However, it does not force anyone to generate such a performance or to invest in active and climate-relevant sectors: this is why the climate label exists.
I therefore take an example to illustrate the controversy between the labels and the denominations chosen by the banks. The CPR Invest - Climate Action should, according to the denomination, invest in companies that promote the climate: after all, it is called Climate Action and it has the Luxflag "ESG" label. So I can be pretty sure that there is only good in it, right? But I am also wondering right away why the fund does not have the climate label, as it has the word Climate in its denomination. Something must be off, I think.
A look at the fund's portfolio shows why it only deserves the ESG label: it may not contain harmful titles as such, but with Orsted and First Solar there are only two titles invested in climate-relevant sectors, fir c. 3% of the fund. With Equinor, EDP and Repsol, the fund contains three companies that are still significantly based on fossil fuels, but committed to a transition [for c. 2.5%]. The other companies are mostly invested in the tertiary sector, technology or consumer goods. That is not exactly what I imagine of a 'Climate Action' fund.
Despite this example, I would also like to emphasize: the Luxflag label is a great initiative and an “ESG” fund is definitely better than nothing! If a critical mass of investors made only ESG investments (for instance in the least polluting companies), these "cleaner" companies would attract higher valuation and accordingly the “less clean” companies would also want to improve to become more valuable. And we must not forget that many investors, for instance for reasons of diversification as mentioned above, cannot or will not go exclusively into sustainable or green sectors.
Another initiative is The Green Exchange, that performs a similar analysis as Luxflag, but for bonds. Every product listed on the Green Exchange uses proceeds raised by the issuance of the bond to finance sustainable, social or green projects.
The criteria are clearly defined by international bodies with a certain reputation. The only limit is probably that the Green Exchange also accepts the terminology of the People Bank of China (PBoC), that list "clean coal" or retrofit of fossil energy plants as green technology. While this is only a theoretical example, it illustrates that there are controversies in this area as well.
Graph: own illustration - Infosource: Green Exchange
To get a common understanding, the European Union has introduced a taxonomy, which aims to regulate "sustainable" activities in the business and financial world and that will come into force from 2022 onwards. Relevant environmental sectors such as adaptation to or mitigation of climate change, circular economy, pollution and protection of biodiversity, water and ecosystems are listed as green sectors. It remains to be seen how this taxonomy will be applied in practice, as it still leaves much room for interpretation and application in the fund world.
Why are not more investments sustainable or green?
The universe of the above funds is often a large or mid cap public equity universe, which means shares of listed companies that will already be valued over a billion. For the bonds, there are listed bonds that are also issued by companies with a certain maturity.
On the other hand, "green" companies are often younger, because the subjects have only recently emerged as a priority. Thus, those companies are often still private as the size and maturity do not yet allow to reach a wider target audience. These are companies that are therefore supported by private equity or venture capital funds, and these funds are not accessible to the private investor as they are too illiquid and often only invest large tickets.
I have been dealing with the subject for quite some time and have opted for a variety of funds and own investments. I'll leave some examples below.
I recently invested a fund from BNP Paribas, called the World Climate Carbon Offset Plan. The fund is probably only pursues a "best-in-class" approach and holds companies like Nike or Sydney Airport. The big difference, however, is that the fund compensates for the emissions of portfolio companies.
Haters say that this is a cheap approach to buying a green stamp, but I have often stated that I am a big fan of carbon credits: if every investor did buy carbon credits, every company in the world would be CO2 neutral, provided that offsets flow to credible organizations. I would prefer that companies buy offsets directly rather than the fund, then the market could decide whether this is of added value for the company.
I also opened a portfolio with an online trader. There, I invested in stocks that convinced me because I believe in the subjects (ie: "high conviction"), less so because I conducted a fundamental analysis of the company. I give a tour of companies I like here, even though it may sound as if I rode a hype train.
Beyond Meat: Vegetarian meat. The meat industry, in particular red meat, is one of the biggest polluters. The Beyond Meat burger [and other products] may not be healthier than meat, but at least they are better for the environment.
Hoffmann Green Cement: as the name implies, "green" cement. They promise an 80% reduction in CO2 compared to normal cement but have yet to accelerate their sales. Accordingly, they might be overvalued and there is a high risk involved, but it also shows the need for solutions in the market.
Re:newcell: recycled cotton. Clothes are non-recyclable today and we need solutions to make fast paced consumption sustainable. This investment, like the cement above, is also associated with high risk.
Orsted: ... just because I adore offshore wind.
Tomra: Recycling Sensors. We need a high-tech collection and separation of waste if we want to enable a circular economy.
Then there are exchange traded funds [ETFs], i.e. products that “group” green companies and perform like funds or indices. Let me mention the iShares Global Clean Energy as an example, which is composed of green energy companies. There are also renewable energy or investors in green companies such as Greencoat, Impax or Encavis, which came back impressively after the first wave t of the corona crisis.
The national pension fund
Every Luxembourger is at least indirectly exposed to the subject of investing, because a proportion of everyone's savings is indirectly managed by the pension fund: the “Fonds de Compensation” [FDC]. The FDC is controversial in its approach: there are already good articles by Jeffrey Drui of the Young Democrats, Fabricio Costa of the Young Greens or Greenpeace that illustrate their failure.
The pension fund is still significantly invested in fossil fuels and continues to invest actively in them. They defend themselves behind the "conventional wisdom" of diversification and risk minimization: "our placements must respect the principles of risk-appropriate diversification".
I would also like to point out that a little less than a third of the FDC's investments are ESG certified, even though we have seen during this article that this is not always in the interests of climate and that investments in polluting sectors are not excluded.
What I want to illustrate is that this subject is being dealt with in a very sluggish manner and that I wish to see more proactivity of the government. Gramegna & Co. like to adorn themselves with the green financial center, but as so often they do not lead by example. We may domicile the green stock market and Luxflag, but much remains to be done for Luxembourg to present itself as a leader in green finance.
There are many levers to implement more initiatives. One option is that every Luxembourg-based fund must do sectoral reporting in accordance with the EU taxonomy [starting with the FDC] and that these reports have to be shared with clients, or even be made public. If any fund had to publicly share that only low proportions are invested in sustainable companies, clients might ask more questions and demand more actively for a change. Luxembourg is the second largest fund domiciliator in the world - just imagine what an impact that would have!
Another option would be to oblige every Luxembourgish bank or financial institution with headquarters in Luxembourg to have a minimum of green products in the catalog. This will create an offer and give the clientele the choice to invest more sustainably.
In uncertain times, it is even more important right we start to design the financial system sustainably.
All pictures are from Pixabay or the Wix Library