6 Myths About Sustainable Investments in a Reality Check
A few years ago it was unimaginable, but the trend is clear: the topic of sustainability has become an integral part of everyday life and is becoming increasingly important for many people, but also for banks and insurance companies. The EU's ambitious but also necessary goal is for Europe to be the first continent to be climate neutral by 2050. To achieve this goal, money is needed - a lot of money. The required investments of 260 billion euros per year are to come to a large extent from the financial sector, where private and public capital is to be redirected into sustainable areas.
Investors as the key to change
Thus, not only banks as financial intermediaries are at the centre of the socio-ecological transformation, but also investors. More and more people are taking ESG aspects into account in their investment decisions (see as well: Sustainable Finance) and choosing a sustainable alternative instead of conventional offers. According to Statista, more than 40% of all private investors in Germany consider it important to invest their money in companies that offer sustainable products or services. For many it has a high importance in theory, but in practice many still shy away from investing in sustainable investments. This is partly due to the fact that there is still a lack of knowledge, but also preconceptions about this topic. We have checked the 6 most common myths thoroughly.
1. Sustainable investments generate a low rate of return!
This myth still persists in some ways, even though it has long since been disproved. Because whether one should invest according to a good conscience or profit-oriented is not an either-or question: ESG investments yield at least on par! And what's more: various studies, among others by Absolut Research GmbH, prove that sustainable equity strategies sometimes even leave conventional strategies behind.
More, please!
Under certain circumstances, it is even possible to generate a higher return with sustainable investments than with products that do not explicitly take ESG criteria into account. One reason for this is that companies that focus on ethical, environmental or social criteria are often not only more innovative, but above all more resilient to ESG risks such as environmental risks and their consequences for the supply chain. This gives them a clear advantage over their conventional competitors. Experts even say that sustainable products will perform better than conventional ones in the long run.
In addition, a study by the rating agency Scope found that sustainable equity funds even achieved a 1% point higher return over a five-year period than conventional funds and they are subject to fewer price fluctuations overall.
Double return?
In addition to financial returns, sustainable investments also have social and environmental returns compared to conventional options. This means that they not only generate financial gains, but also have a benefit for society. So if the financial return of sustainable investments is already good, you can even achieve a double return with sustainable investments.
2. Sustainable investing is expensive!
In general, it can be said that some financial products that are labelled as sustainable can be somewhat more expensive. BUT: This is mainly due to the additional cost components such as fund management costs for active funds, costs for the elaborate certification of a sustainable fund or the numerous information providers have to research and provide on sustainability, which lead to a higher total sum.
Head-to-head with conventional offers
On average, however, it can be said that apart from certain exceptions - for example in special segments or when premiums are skimmed off for sustainability products - sustainable equity and bond funds are not more expensive. This was confirmed by a study of the annual fees of various fund categories by EFAMA. On average, sustainable funds are even cheaper for investors than conventional products. According to ESMA, the annual fees for sustainable equity funds averaged 1.3 per cent between 2018 and 2021, while those for non-sustainable funds were 2.0 per cent. Sustainable mixed funds also cost less and gained more in value over the last 3 years than conventional ones.
Overall, at least for actively managed funds, the costs of sustainable and conventional funds are similar. The running costs of sustainable equity funds are now roughly on a par with those of conventional equity funds, generally between 0.8 and 2.2% per year. Of course, choosing a fund with lower costs would also increase the (net) return opportunities. In the case of passively managed funds, the management costs and thus also the management fees are lower. This is because sustainable variants also exist in exchange-traded index funds and ETFs (Exchange Traded Funds).
Good prospects
The forecast that the fees of sustainable funds are more likely to fall than to rise can also be based on the rapid expansion of the sustainable product range and the intensified competition among providers. New funds in particular are often offered at more favourable conditions. And since sustainable funds are on average younger than conventional products, they have lower costs on average.
3. I do not have sufficient diversification with sustainable investments!
Generally speaking, it can be said: Every conscious investment decision has an impact on diversification. Here too, however, the risk is no higher than with the conventional counterpart.
Just as with conventional investments, the decisive portfolio mix, i.e. diversification across various themes, companies, sectors, countries, currencies and also asset classes (e.g. shares, funds, bonds) is a good approach.
The risk of loss is also reduced if the investment amount is spread over a sufficient number of issuers, which at best are not related to each other. Risk diversification is therefore naturally just as possible with a sustainably oriented portfolio as with conventional ones.
The strategy counts
Here, it also depends on the specific investment strategy. Negative lists should be less strict or there should not be too many exclusion criteria at once. Otherwise, this would lead to low diversification and thus to higher risk and possibly even to losses. A tolerance limit of 5% is also a common approach to prevent exclusion criteria from having too strong an effect.
However, it can also follow the best-in-class approach or even use the best-in-progress strategy. In the latter, investments are made in companies that have progressed significantly further or faster relative to their competitors on the path to a more sustainable way of doing business or have innovative concepts for change. This approach also has the advantage that sustainability is not viewed in black and white, but dynamically.
4. 100% sustainable investment is the only way to a sustainable economy!
Theoretically, it is possible to set the share of sustainable investments in the investment process at 100%. But in practice it is actually hardly possible to implement this, because 100% sustainable investments in the sense of the EU criteria are hardly achievable. At the product level, "impact products", i.e. dark green funds (Article 9), etc., have hardly been offered so far, as many previous Article 9 products have also been downgraded to 8. The number of Article 8 products, i.e. light green funds that take into account negative impacts on sustainability factors, is therefore comparatively much higher.
Is there THE sustainable company?
It is also difficult at the company level, as there are several predefined sustainability goals. It is hardly possible to find a company where no big "but" can be discovered. Because often companies act well with regard to one goal, e.g. from the social area, but rather poorly for another goal such as biodiversity or the like. The perfect sustainable company probably does not exist, especially if the entire value chain is included. So it depends on what sustainability means to you and where you want to focus your ESG factors.
After all, sustainability is not a state, but a process!
In fact, it can sometimes have a greater impact on the transformation process towards a sustainable world to support companies that are not yet 100% sustainable, but credibly communicate that they will be almost carbon neutral in a few years or are in the process of changing towards sustainable behaviour and corporate governance.
5. By investing in ESG, I am taking a higher risk!
In general, it can be said that every investment carries risks and sustainable variants have the same chances of return and risks of loss as conventional investments. Sustainable investments are not by definition safer or more unsafe than comparable conventional investments.
However, they have different risks than conventional funds. For example, there is a risk of greenwashing with some financial products, as some regulations are not yet standardised and there is still a lack of decisive standards (See as well: Greenwashing).
The type of product determines the risk
Moreover, many sustainable funds have only been on the market for a short time, so there are no long-term considerations yet. However, the probability of risk depends primarily on the type of product. With narrowly focused themes or sector funds, for example, diversification is limited by a sector focus.
And when investing in growth companies, a somewhat higher risk is taken and one may have to accept greater price fluctuations. In addition, direct financial investments in solar parks, wind turbines, reforestation or similar have a rather low liquidity than other types of funds and ETFs. For example, if you invest exclusively in companies from the renewable energy sector, you cannot compensate for price slumps with profits in other sectors. Then there is a so-called cluster risk.
Resilience through ESG integration
However, sustainable investments not only have other risks, but also other advantages:
Sustainable investments are often associated with fewer environmental or casualty risks, as they are better equipped to deal with external factors such as climate change-related supply shortages. ESG business models are also associated with less market risk and are more robust in times of crisis, as the Corona pandemic has shown, according to studies. This is partly because certain risks have already been excluded and the investments focus on promising growth markets and/or the corporate governance is built on a solid, transparent structure.
Loss of value due to climate change
Sustainability risks are also economic risks. For companies that do not include ESG factors in their business model, there is a higher risk of being exposed to the consequences of climate change (physical risks), but also to the new political regulations from this area (transitory risks), because they are less prepared for them. In the extreme case, this can even mean that these companies become a "stranded asset", i.e. completely worthless and no longer generate a return. Such a company will suffer economically in the medium and long term - and, consequently, so will the investors.
6. I can't make a difference by investing sustainably!
Yes, you can. Even if small private investors, for example, have less influence on the market than large ones, they increase the pressure and create awareness by investing in sustainable products and companies. Especially if more and more people decide in favour of sustainable investments. With their capital, investors have a steering function and contribute to companies tapping future market potential, thus promoting the competitiveness of sustainably oriented companies and countries. At the same time, they can act as financial supporters for companies that are in the process of transforming towards more sustainability.
Every vote counts
In addition, fund management companies manage the money of millions of investors and thus bundle shareholder voting rights, which the companies can in turn actively use through engagement in meetings and the like to call on companies to act. Impact investments, in particular, can serve as an effect-oriented investment option that pays targeted attention to specific sustainability goals such as the SDGs.
There is still room for improvement, but impact investments are gaining in importance, and private and institutional investors are increasingly asking for them. Impact investments can also help to direct the rapid progress in areas such as digitalisation, AI or biotechnology towards social and ecological impact and benefit particularly neglected target groups.
However, sustainable investments alone are not enough to stop climate change. Sustainable consumer behaviour in everyday life is central: eating vegetarian or vegan food, using public transport instead of cars and getting electricity from renewable sources are just a few ways to make your contribution.
When, if not now?
It is therefore worth taking a closer look at sustainable investments and investing more closely. Since August 2022, it has been a legal requirement for investment advisors to ask their clients about sustainability and their preferences in investment discussions, to explain them and to include them in the investment advice.
If you want to invest your money one way or another, why not in sustainable options? This holds the chance to not only achieve returns through investment, but also to help shape the future of our world to a certain extent, and to do so now, when it is urgently needed.
The central questions at this point are therefore: How do we want to live in the future? How do the younger generations in particular want to live? How does my behaviour affect the entire world? And also: What can I do?