The Stocks Behind Sustainable Investment Funds

Many investors are turning to sustainable investment funds. Private investors too are increasingly looking for ways to invest their money in an ecologically- and ethically-responsible way. Swiss banks have long adapted to this demand and now offer countless funds which label themselves as sustainable.

But do these funds actually invest in, and how are they different from standard mutual funds? To answer this question, moneyland.ch took a closer look at a number of Swiss stock funds which are marketed as sustainable investment vehicles.

Nestlé, Roche, Novartis

At first glance, sustainable funds are nearly identical to standard funds. The three most heavily-weighted companies on the Swiss Performance Index (SPI) – namely Nestlé, Novartis and Roche – are found in most sustainable funds. The SPI tracks the broader Swiss stock market, with more than 200 stocks represented. Nestlé, Novartis and Roche typically take top place in the portfolios of sustainable investments funds. In some cases, these three stocks make up more than half of these funds.

*Fund is advertised as following ESG guidelines.
**Fund follows an index

One could be forgiven for thinking that Swiss banks consider Nestlé to be the most sustainable Swiss company. The food-processing giant is the biggest investment position of most sustainable funds. In many cases, Nestlé is even more strongly weighed in sustainable funds than in standard funds. Only Raiffeisen does not include Nestlé stock in its sustainable investment products.  

But in communications with moneyland.ch, banks have stressed the fact that just because a company is more heavily weighted does not mean that it is a particularly sustainable company. The real reason why stocks like Nestlé’s make up the bulk of almost Swiss stock fund labelled as sustainable has nothing to do with sustainability at all. Markus Signer, head of Intermediaries at Pictet, told moneyland.ch that holding Nestlé, Novartis, and Roche stock is virtually unavoidable for anyone who wants to invest in the Swiss stock market. The reason is that those three stocks make up nearly half of the SPI.

Because the funds included in the comparison aim to outdo the SPI’s performance, the weightings given to different stocks have to match those of the SPI, to some extent. If they did not, the fund’s price could strongly deviate from the so-called benchmark. Urs Aeberli from Migros Bank told moneyland.ch that customers expect returns on sustainable investments to correspond to market norms, and that is why Swiss large cap stocks are considered as long as they do not match exclusion criteria and fulfill the bank’s minimum ESG requirements.

Raiffeisen stands out as the only service provider to exclude Nestlé from its sustainable funds. The reasons for this are controversies linked to production processes, as the bank explained to moneyland.ch. Additionally, Novartis is not among the biggest positions in Raiffeisen’s sustainable funds. Here too, the bank names current controversies and changes to its rating process as the reasons for this. Instead, other SPI stocks like Roche and ABB are the most heavily weighted. This exception shows that funds marketed as sustainable do not necessarily have to invest in the biggest Swiss companies.

Controversial companies

Fund managers understand that the sustainability of giant corporations like Nestlé is a topic of controversy amount private investors. But with the exception of Raiffeisen, the banks argue that while Nestlé has been criticized on some points, as a whole the company has a positive sustainability balance. Many banks refer to the MSCI Sustainability Index, on which Nestlé has an excellent AA rating.

Fabio Pellizari, who is responsible for the sustainability strategy of ZKB funds at Swisscanto, argues that investing in controversial companies can produce a positive impact. He explains that they discuss controversial topics with the boards of these companies, which take them seriously because they are among the biggest investors in many Swiss public companies that have large free floats. The logic is that big companies like Nestlé will put more effort into operating sustainably because fund managers expect it of them. Other banks too name so-called active ownership as playing a role in their sustainable investment products.    

All providers also stress that the makeups of individual funds have become more transparent. They reference the wealth of documentation which is now available on their websites. But Signer from Pictet does clarify that customers do tend to look at big corporations as problematic with regards to sustainability – even though that is not always the case – and that in many cases they do not understand how heavily these companies are weighted in funds.

Banks promise careful selection

The similarities between sustainable funds and standard funds raise an important question: What exactly are the differences between the two? Banks stress that stocks included in sustainable funds are carefully selected based on ESG criteria (environmental, social, governance). Typically, this process has the following results:

• Some companies are excluded based on concrete criteria. Migros Bank, for example, names reprehensible business models like controversial weapons and coal production. Many sustainable funds do not include building material manufacturer LafageHolcim, which is heavily weighted in the SPI. Airlines too are often excluded.
• Companies are often selected, privileged, or more heavily represented in sustainable funds based on their sustainability ratings as compared to other companies in their industry (best in class methodology). That means companies may be given top positions in portfolios as long as their ESG ratings are better than those of their competitors – even if their ratings are poor compared to the most sustainable companies in other sectors.

But fund managers do not share a unified standard for the criteria used and the weight they carry. Pictet, for example, says it currently rates Novartis poorly due to bribery scandals in the US. Accordingly, the weighting it uses for that company is slightly lower than that of the SPI. At the Zürcher Kantonalbank (ZKB), on the contrary, Novartis has one of the highest ratings and is weighted more heavily.

Specialized funds vs. the Swiss stock market

If you do not want to invest a large part of your wealth in Nestlé, Novartis, and Roche, you can opt for one of the specialized sustainable funds offered by many banks. These funds usually place a stronger emphasis on the impact of companies, compared to the funds included in this comparison. The tradeoff is that often, your money is invested in relatively small companies (small caps), and investments are not focused on the Swiss stock market.

Are sustainable funds profitable?

When it comes to profitability, providers typically claim that investing sustainably does not result in lower returns. The comparison paints a somewhat sketchy picture: Some sustainable funds have delivered higher returns than standard investment funds from the same provider, while others have not.

UBS, for example, offers a Swiss stock fund labelled as sustainable which has delivered a gross return of 70.69 percent over the past five years. That is substantially more than UBS’s income fund (57.24 percent) and slightly more than the its dividend fund (69.19 percent), both of which do not bear the sustainable label.

Source: UBS Date; 24.08.2021
* Fund is advertised as following ESG guidelines.

Pictet’s sustainable fund, on the other hand, has performed relatively poorly, delivering a return of just 58.85 percent over 5 years. Pictet’s standard fund returned 92.19 percent.

Source: Pictet, Date: 30.07.2021
* Fund is advertised as following ESG guidelines.

So whether a fund is marked as sustainable or not does not seem to be the determining factor when it comes to performance. At least that is the case of Swiss stock funds, which generally have similar makeups regardless of whether or not they have sustainable branding.

Banks cannot beat benchmarks

If you compare the performance of sustainable funds to that of the SPI – the accepted benchmark of many Swiss stock funds – it is apparent that fund managers rarely manage to beat that index. Not one of the sustainable funds included in the comparison has outperformed the SPI in terms of returns.

What that means is: By investing using actively-managed funds, you risk earning smaller returns in addition to paying higher fees. Sustainable ETFs provide an alternative, but there are few options for investing in Swiss stocks.

Verdict

“Just about every Swiss stock is sustainable enough – as far as the financial world is concerned – to be included in a sustainable fund,” explains moneyland.ch analyst Raphael Knecht. “With a few exceptions, sustainable financial products only differ from standard ones in terms of how stocks are weighted.”

Resultingly, it should be relatively easy to convert standard Swiss investment products into sustainable ones. Many banks, including Credit Suisse and Raiffeisen, aim to apply ESG criteria to all of their investment products. “Because the differences between Swiss sustainable and standard funds are already small, we will likely see many standard investment products being branded as sustainable overnight, without many changes in the way capital is allocated,” expects Knecht.

Customers who are less forgiving in their assessments of SPI heavyweights than the financial sector is should review the makeup of sustainable fund portfolios when choosing investments. Even controversial companies are rarely fully excluded. “Depending on your personal expectations, you may have no other choice than to either use funds which invest in foreign companies, or put together your own stock portfolio yourself,” says Knecht.

The asset allocation of many funds is dictated by the gains of their benchmark index. “If you choose to invest in other companies which you consider to be more sustainable, you should understand that returns may differ strongly from those of the stock market as a whole, and can be lower,” concludes Knecht.

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