Sustainable investment. In future, more and more capital will only be made available to companies that behave in an exemplary manner in terms of ESG - environmental, social and corporate governance. Or make a positive contribution to our society through their business model, products and services. A megatrend has gained momentum and will continue to accelerate in the future.

In each decade, events on the capital market can be described with a catchy combination of letters. The 2000s belonged to the emerging markets - BRIC. In the decade that followed, technology was the trump card - FANG. And now the age of sustainability is beginning - ESG.

In 2020 alone, according to ratings agency Morningstar, €233 billion flowed into ESG funds in Europe - twice as much as in 2019 and five times more than five years ago. Assets invested in sustainable funds thus surpassed the one trillion euro mark for the first time. Compared to 2010, this is a tenfold increase.

"More and more investors are realising that we can no longer continue to do business as usual. Sustainability has become a social trend," explains Stefanie Rath, fund manager at Robeco.

But there are more reasons for this remarkable development. Investor interest has also been fuelled by the outstanding performance of these investments. Sustainable funds have been outperforming the broad market for some time, but this accelerated in 2020. It's important to keep in mind, however, that the sectors most affected by the Corona crisis - airlines, cruise, energy - are generally weighted low in sustainable funds. "Nevertheless, the narrative that sustainability and returns don't work together is now finally off the table. Instead of 'good conscience or good performance', the future could be 'good conscience and good performance'," Huub van der Riet, fund manager at NN Investment Partners, is convinced.

The fact is that transforming the economy requires a huge financial effort. And wherever there is a lot of money flowing, there are also opportunities for returns and investment. The International Renewable Energy Agency estimates that the investment needed to transition to a sustainable energy supply compatible with the two-degree target by 2030 alone will be $60 trillion. Smart logistics, smart cities, smart grids and smart agriculture are the answer to the challenges of the future. Hans-Jörg Naumer, Chief Strategist at Allianz Global Investors, is therefore already talking about the green wave of growth: "Climate change is the final, unmistakable wake-up call for this ecological truth. The pressure to act that it will bring will transform the economy in almost every sector and lead to a new phase of growth."

There is a third point at play. Sustainable investing is getting massive support from politicians. The EU wants to put pressure on companies to meet their climate targets. However, because bans would cost jobs and votes, attempts are now being made to play through the fences - via the capital market. On the one hand, new transparency regulations ensure that the area of sustainable investments becomes more comprehensible for investors. On the other hand, in future every fund buyer must be asked in the advisory discussion whether he is not also interested in sustainably investing funds. This is of course suggestive, but will result in even more capital flowing into this sector in the future.

Consistently, all fund providers are now dealing intensively with this topic. In 2020 alone, 505 new ESG funds came to market in Europe, according to Morningstar. More than 250 conventional funds were repositioned towards "green" by including binding ESG criteria in their investment objectives.

Because the supply of sustainable products is growing and investor demand is increasing, the pressure on companies is now actually increasing. Those who do not adapt will not be able to access capital at all in the future - or only at very poor conditions. The process of change continues to accelerate.

There are basically two strategies for investors to participate in this trend. The most widespread are ESG products. The main aim here is to avoid the risks arising from environmental, social and governance issues. After all, these have a direct or indirect impact on business performance. A company that wastes resources, treats its employees badly and is poorly managed has never been a good long-term investment.

"ESG is primarily oriented around the footprint of companies - how much of an impact they have on the environment, how they pay attention to social issues, and how well the company is managed. It's about doing as little damage as possible," explains Christian Klein, professor of sustainable finance at the University of Kassel, "but the bigger issue right now is impact investing - investing in companies whose products and services help make our world a better place, solve specific problems, and thus reduce society's overall footprint."

Because this idea is so intriguing, it is rapidly gaining followers. Capital is supposed to actually make a difference. "But that requires first having a detailed conversation about what impact means," Klein makes clear. "Is something really happening as a result of my investment? Or would it have happened the same way? And what does it mean for the risk-return constellation of such investments: does that change compared to conventional investments, because now projects are being financed that would not have been financed before because they seemed too risky or their returns too low?" The discussion about this, Klein said, is not being done enough right now "because everyone is in an impact gold rush mood. We're going to have to do a lot more on that."

Basically, it can be stated: Impact investments can be broad-based or focus on specific aspects of the broad field of sustainable investing - carbon neutrality or water, for example. And because fund managers typically apply additional stringent sustainability filters to this strategy, they are considered to be at the top of the sustainability pyramid - dark green funds. Two concrete, exciting investment ideas are presented by private-wealth partners NN Investment Partners and Robeco on the following pages. ®

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// How Brussels is putting the squeeze on sustainability.

The long-term goal of the EU Commission's action plan for the fund industry is clear: at some point, there should be an indicator that shows exactly how well or how poorly the investments of individual funds perform in relation to the EU's sustainability goals.

To make this transparent for investors, all funds are to be classified by the end of 2020. Non-sustainable funds will be listed as Article Six funds. Article eight funds are ESG funds that explicitly consider sustainable objectives in their investment strategy - i.e. define certain exclusions and apply sustainability filters when selecting stocks. Article nine funds are impact funds. In addition to the ESG strategy, they must also pursue sustainability goals in a measurable and verifiable manner. In the German implementation of this EU requirement, article-eight funds are to be labelled "E", article-nine funds "I".

The next major regulatory step will then be the implementation of the so-called taxonomy. Under this term, the EU is creating a system to determine whether and when certain business activities meet the criteria for green business.Steel production, for example, is taxonomy-compliant as long as CO2 emissions are below a predefined limit. "Funds must then disclose an aggregate figure:What proportion does a particular company have in its portfolio? And what proportion of activities there are taxonomy-compliant? In this way, over time, the taxonomy-compliant shares of different funds should become transparent and comparable for investors," explains Georg Haumann of the fund association BVI.

So far, the EU has only detailed two environmental objectives in the taxonomy - reducing global warming and adapting to climate change. The technical regulations on these already cover around 400 pages. Four more targets are to be implemented in the coming months. "And in two years, the EU wants to have taxonomised the entire ESG issue," says Christian Klein and concludes: "The effort is gigantic. We're talking about something really big here. The taxonomy will fundamentally change the way we think about sustainability."

For example, the huge sums from the Corona Reconstruction Fund could be distributed with the taxonomy in mind. And at some point, it will be a matter of whether a company can still get credit from its bank if it is just not taxonomy compliant in many activities. "I can only advise investors not to underestimate the EU on this point and to consider this aspect in their investments now," informs Christian Klein.

However, one question remains: Can it really be purposeful when bureaucrats decide what is sustainable?

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Author: Klaus Meitinger