Everyone is talking about “sustainability” and “ESG”. On the one hand, the financial industry is facing new regulatory and supervisory requirements, while on the other hand, investors are also showing increased interest in sustainable finance, generally driven by three incentives:

• Investors want a better risk-return profile through the inclusion of ESG and/or sustainability factors.
• Investors want their investments to reflect their values and moral convictions.
• Investors want their money to have a positive impact on the environment and society.

Measuring sustainability and ESG factors is a challenge. But it is crucial for investors to obtain the most accurate information possible and to make investment decisions in line with their incentives.

Differentiating between “ESG” and “sustainability” in a financial context

Anyone who works with financial instruments will inevitably come across terms such as “sustainability” and “ESG”. These are often used interchangeably, but it is particularly important in the financial sector to differentiate between the two so that investors can better understand investment opportunities and products, and make informed decisions.

ESG

ESG is an acronym that stands for

• Environmental
• Social
• Governance

ESG ratings form part of risk management. Their aim is to assess and quantify the environmental, social and governance performance of companies. These assessments can help investors better understand long-term risks and opportunities and incorporate them into their investment decisions. The three factors are generally divided into subcategories, analysed and assessed separately. The “environmental” factor, for example, analyses air pollution, water consumption and CO₂ emissions. When ESG ratings are assigned to issuing companies, this is usually done by rating agencies based on their own models. As a result, there is little correlation between the different ESG ratings. It is a good idea to do some research on the valuation model used.

Sustainability

In order for financial products to be designated as “sustainable”, they must have a demonstrable positive impact on the environment and society. For example, by making a direct contribution to overarching goals such as limiting global warming to a maximum of 1.5 degrees Celsius or preserving biodiversity. As a result, the term “sustainability” in the context of investment is closely linked to a specific social and/or environmental impact, which means the definition is narrow.

Sustainable investment approaches at a glance

Investors use sustainable investment approaches to integrate ESG and/or sustainability factors into their investment decisions. Each investment approach has its strengths and weaknesses. Combined, however, these can be compensated for, and impact can be enhanced. This is why you should ensure that an ESG or sustainable financial instrument adopts multiple approaches. The following approaches are currently used:

ESG integration

ESG integration means integrating ESG opportunities and risks directly into conventional financial analysis. ESG criteria are systematically taken into account when making investment decisions, and investments are required to meet both financial and ESG criteria. See “ESG” section.

Exclusion

Exclusions are targeted decisions to exclude certain companies or countries from a portfolio based on criteria such as business practices or adherence to values. These exclusions are either unconditional due to conflicts of values or ESG risks, or conditional due to negative business practices such as breaches of certain standards or violations of human rights. An example of this is the exclusion of oil, gas and coal companies.

Positive selection

In the case of positive selection, investments are considered only if they meet certain minimum sustainability criteria, which can be defined based on sustainability ratings or other key figures.

Best-in-class approach

When using the best-in-class approach, investors select companies with the strongest ESG performance in their sector. Companies with ESG ratings above a defined threshold are considered investible. By adopting this approach, companies in less sustainable sectors can be selected, provided they lead the way in ESG criteria.

Sustainable thematic approach

Sustainable thematic investments invest in companies or countries that help implement environmental and social solutions, such as renewable energy, education or healthcare systems, and in this way tackle environmental and social challenges.

Read more about thematic investments in our blog post “Thematic investments – how to invest in megatrends”.

Impact investment

In addition to a financial return, impact investments also aim to have a measurable positive impact on environmental and social developments. The positive effect must be declared and measurable, which is not always easy to do.

Active shareholder policy

Through an active shareholder policy, investors can influence how the company handles ESG or sustainability issues. There are generally two options available to you:

Company dialogue

When it comes to commitment, investors engage in dialogue to exert an influence. They communicate with group management and make suggestions for changes. To add weight to their demands, investors often join forces and devise initiatives. 

Exercising voting rights

By exercising their voting rights, investors can raise environmental and social concerns with companies that are not in line with their ESG or sustainability principles.

How to find sustainability-related investments that are right for you

If you are familiar with the concepts and approaches presented here, you have a good basis for finding investments that match one or more of your incentives. In addition to the general questions you should ask yourself when building up your personal investment portfolio, you can consider the following:

• Do you want to invest in companies that have ESG risks under control, or in companies that minimize their negative environmental and social impact or maximize their positive ones?
• Are there any sustainability issues that are particularly important to you?
• How much time do you have to invest in researching the rating systems used?
• Which sectors and companies do you not want to invest in under any circumstances?
• Which financial instrument (investment fund, individual securities, etc.) is best suited to your objectives?

A personal consultation can clarify all these considerations and help you identify the best investment opportunity.

Go to our comprehensive investment guide.

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