Sustainable Funds: What to Consider

Many Swiss financial services providers market their funds as sustainable in order to attract customers. As a result, the choice of products which are hailed as sustainable is huge, with a spectrum ranging from actively-managed theme funds to passively-managed exchange-traded funds (ETFs) and index funds.

Those who prefer not to invest through conventional banks will also find robo advisors and retirement planning apps which promise their users sustainable investing.

But what is really behind products which are marketed under the blanket term of sustainability is often unclear. In this guide, moneyland.ch answers questions about sustainable financial products.

What does sustainable investment actually mean?

Unfortunately, there is no clear, unified definition of the term sustainability. The term sustainable, as it is used (or misused) in finance, simply means that investments account for eco-social factors. But neither financial services providers nor their customers fully agree on which factors should be accounted for, nor on how much weight should be given to each.

Service providers like banks use different sets of guidelines for products marketed as sustainable. Normally, the sustainability of a security is rated based on so-called ESG criteria. ESG stands for environment, social, governance. The term encompasses a plethora of factors including ecological balance, employment conditions and corporate transparency.

But there are no unified standards for how individual factors should be rated. This is a common cause of confusion and false expectations for customers. For example, many investors feel that the risks associated with nuclear energy are too high for atomic power to be considered sustainable. But sustainable funds may still invest in the stocks of companies which produce nuclear power because they have low CO₂ footprints.

How do fund managers choose the stocks for sustainable funds?

The best-in-class model is widely used. Many banks label funds as sustainable if they include the stocks of companies with relatively good eco-social ratings compared to other companies in their sector.

This method is widely questioned because it can be applied to sectors which are hardly sustainable. For example, a fund marketed as sustainable may invest in a petroleum company because that company’s CO₂ balance if better than those of its competitors.

The best-in-class model gives fund managers a lot of wiggle room when putting together investment products. Because of this model, you may find sustainable funds which invest in companies which do not have strong ecological or social commitments, and even companies with controversial business practices.

Are there criteria which rule out particularly unsustainable companies?

Practically all financial services providers will exclude a stock from their sustainable portfolios if the company is seen as a hindrance to sustainable development. Conventional factors used to rule out companies include destruction of the environment, human rights violations, weapons dealing, nuclear energy, and corruption.

Thresholds are also commonly used. For example, a fund may decide not to invest in companies which generate more than five percent of their revenues from coal-generated power. This gives companies some room to practice unsustainable activities without being excluded from funds.

This model is often called socially responsible investment (SRI). Each financial services provider selects its own exclusion criteria. In many cases, different funds from the same fund manager may use different sets of rules (often labelled by terms such as «responsible», «ESG» or «sustainable»).

Do sustainable funds have a positive impact?

A common misconception is that sustainable financial products must have a measurable, positive impact on the environment and society – such as a reduction in CO₂ emissions or a spike in education.

These kinds of investment products do exist. They are often referred to as impact investments. But not all Swiss sustainable funds fall into this category. It is important to understand the difference between investments which are considered sustainable, and investments which result in social or ecological change.

How do I go about finding truly sustainable funds?

You can get an initial overview by comparing ESG ratings of different funds online. Sustainability badges – like the FNG badge from the Forum Nachhaltige Geldanlagen (FNG) – can be useful. This badge, for example, indicates whether the eco-social engagement of a financial service provider is solidly grounded, instead of just looking at ESG criteria.

Because customers also define sustainability differently, you cannot really get around taking a closer look at individual investment products before you invest. You can find out which investment strategy underpins a fund, whether exclusions apply, and which stocks make up a large part of a fund’s portfolio using platforms like that of Forum Nachhaltige Geldanlagen.

Fund managers themselves publish the criteria used to create a portfolio and the goal of the fund in key investor information documents (KIIDs). The documentation provided by some funds bear the FNG transparency badge. This badge indicates that investors have access to exceptionally detailed and clear information about the fund in question.

How can banks give the “sustainable” label to their own products?

The term sustainable is not a protected trademark. Any service provider can call its products sustainable without having to fill any special criteria. Financial services providers argue that customers have very different concepts of what the term sustainable means. Because of this, there are many differing opinions with regards to rating investment products.

But the Swiss financial market supervisory authority FINMA wants to prevent possible false advertising and so-called greenwashing. The term greenwashing denotes the controversial practice of a company presenting itself as being more sustainable than it actually is.

What does FINMA do?

Swiss financial services providers need approval from FINMA before they can make a fund public. Foreign funds need to be approved by authorities as well, if they are open to investments from individuals in Switzerland who are not qualified investors.

One criterion is that the name of an investment product cannot be misinterpreted by investors. There have already been instances where FINMA required fund managers to make changes a fund’s name or documentation.  

According to FINMA, regulatory measures can also help to prevent greenwashing. Possibilities include requiring financial services providers to ask each customer what their concept of sustainability is, and to take this into account. Requiring products to be more transparent may also be helpful.

Is sustainable investing worth it, from a financial point of view?

Many investors assume that investment products which follow eco-social criteria deliver smaller returns than other vehicles. That assumption is incorrect. Historically, many sustainable funds have actually yielded higher returns than their conventional counterparts.

Companies which offer sustainable funds claim that sustainability is good for business as well as being good for your conscience. For example, by investing in alternative energy sources early on, you avoid the risk of losing out if governments begin to penalize the fossil fuel industry. So sustainability can be used to hedge your finances against future developments. This makes these products an interesting option for long-term investing.

However, whether such favorable performance actually comes about thanks to sustainability, is disputed. For instance, it is possible that the bulk of a fund’s returns might not come from particularly sustainable companies. If a fund’s managers follow a best-in-class strategy, they will likely try to include lucrative stocks wherever possible, even if those equities do not have extraordinary sustainability ratings.

The above-average fees which were previously charged for investment products with the sustainable label are becoming less common – at least for newly-launched funds. So choosing sustainable or regular investment products no longer has a major impact on the cost of investing. A much more important point to consider is whether a fund is actively or passively managed. Active management and themes-based investing normally generate higher investment costs.  

Are funds the only option for investing sustainably?

No. Any investment vehicle – including stocks, real estate, and commodities – can be sustainable, depending on what you invest in. But sustainability is more of a concern when investing in mutual funds. A fund generally bundles many different assets, and it can quickly become unclear what exactly your money is being invested in. It is generally much easier to estimate how sustainable one company is, than it is to try to determine the sustainability of all the companies a fund invests in.

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The problem with ESG
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