Sustainable investment funds The world of sustainable funds – and what to watch for

Everything you need to know about sustainable investment funds and how to recognise true sustainability in the financial world – read on now.

Sustainable investment funds are on trend in the current financial market. It’s worth taking a closer look behind the scenes: Which funds are truly sustainable? Which funds actually offer good returns and which are too good and too green to be true? The financial market is developing in line with current trends – and is now increasingly dressed in green.

Few banks or providers compete for customers without sustainable investment funds. Sustainable ETFs, ESG investment funds, green funds, impact funds – the spectrum of green investment products is wide. The questions many investors have about these products, which are still a novelty on the financial market, are just as many.

Investors want to know: What are green investment products really good for when it comes to long-term asset preservation or wealth building? And do they really deliver the sustainable impact they promise? In order to answer these and other questions, we take a look behind the scenes of the hype surrounding sustainable investment funds in this article.

While traditional funds focus on the three objectives of profitability, safety and liquidity, sustainable investment funds add sustainability to these. Environmental, social and economic sustainability aspects therefore play an equivalent role. 

So much in theory. However, there are no valid criteria for the definition of sustainable investment funds, as the term “sustainability” is not protected. This makes it easy for many industries – and thus also for the financial market – to jump on the sustainability bandwagon with a supposedly green marketing strategy. In just a few simple steps, conventional products can quickly be dressed up to look more sustainable than they are. 

The United Nations Brundtland Report (1987) provides a definition of sustainability. It defines development as sustainable if it meets the needs of the present generation without limiting or endangering the opportunities and needs of future generations. 

This gives investors a starting point for how to take a closer look at sustainable financial products. Although there are some really well-meaning providers, the financial market is currently flooded with products that are more hype than real in their environmental or social commitment and often vaguely refer to themselves as “environmental funds”.

An overview of the various investment strategies can help you to assess the sustainability of different investment funds: 

Negative screening

This strategy forms the bottom end of the strategy spectrum and can only uncover minimum sustainability requirements. This is because this strategy is about excluding specific industries, companies or countries that explicitly do not operate sustainably, such as the weapons, gambling or nuclear power industries. 

However, this approach does not actively fund sustainable companies or industries. Countless suppliers therefore use it to designate supposedly sustainable products. 

Best-in-class approach

This approach also sets a relatively low threshold for providers to declare their products sustainable. This approach is about identifying the company or product with the greatest sustainability ambitions within a specific category or industry. However, the crux here is that with this approach, even a manufacturer of internal combustion engines or an oil company can become best-in-class – so this is only about relative sustainability, not absolute sustainability. 

ESG approach

This is based on a consideration of the ESG criteria, which comprise environmental, social and governance aspects. 

This means that a sustainable impact of the financial product is not yet demonstrably guaranteed, but investors can be sure that these three sustainability aspects are incorporated into the portfolio design. This approach is the good “middle class” of sustainable investment strategies. 

Impact investing

This investment forms the upper end of the spectrum and has a transparent and demonstrable impact on sustainability in the real economy. Here, it is important for providers to set specific goals that are disclosed to investors. 

Sustainability aspects not only serve as an orientation in impact investing, but are also actively and transparently incorporated into the design of the portfolio. This investment strategy is therefore considered to be particularly sustainable on the financial market.

If the long-term impact can really be ensured, investing money in a sustainable investment fund makes perfect sense on several levels. 

On the one hand, they offer investors access to new or previously inaccessible segments in many cases, such as renewable energy, e-mobility or sustainable infrastructure. By investing in these segments, you have the opportunity to expand your portfolio and at the same time reduce your investment risks through diversification.  

In addition, the popularity of truly sustainable investments is also constantly increasing. The younger generation is getting an increasingly powerful voice in the financial market, calling for a stronger focus on sustainability. In this way, sustainable finances gain long-term prospects that pay off. Financial experts have repeatedly noted that the performance of sustainable investments is above average or at least as good as traditional investment products. 

By taking sustainability into account, companies are also increasing their focus on other aspects, such as certain risks in their supply chain or the precise mechanisms of the market. This enables them to build up resilience and deal with changes flexibly. These characteristics in turn have a positive effect on the success of sustainable companies and thus on demand. 

In addition, sustainable investment funds offer exclusive opportunities and possibilities, in particular due to their sustainability, that conventional financial products cannot offer. 

For example, access to the renewable energy sustainable tangible assets segment. With the rising demand for energy and the steady decline in fossil fuels, renewable energies play a key role in our future energy supply. 

We were thus able to resolve the question of whether and why an investment in sustainable investment funds makes sense. Now it is more a question of which sustainable investment funds are suitable for a meaningful investment. We will now clarify what options are available.

A wide variety of sustainable fund products are available and the differences between them are not always apparent at first glance. So here you will find a broad-based but succinct overview:

Sustainable equity funds

By investing in a fund that trades in shares of listed companies, your investment amount does not flow directly into the respective companies, but to the previous owner of your shares. In this way, your support for the sustainability of a fund or the companies it contains is predominantly indirect.

With a larger number of investments, the stock market price and thus also the value of the respective companies increases. For example, you can implicitly increase the credit rating of the company to facilitate the implementation of sustainable projects. Although you have no significant influence over the company’s objective as an individual retail investor, the more investors there are, the more you can influence in which areas the existing capital is actually invested.

Green bonds (pension funds)

This type of investment works like a traditional bond – the fund lends money to countries or companies that pay interest on it. It is important that the bond is used for sustainable purposes or that non-sustainable sectors and practices are excluded.

ESG criteria often play a role in the selection or exclusion of companies. While green bonds are individual securities, a sustainable bond fund includes a variety of such securities.

Sustainable mixed funds

These types of funds structure their portfolio using investment properties from a variety of categories, such as equities, bonds or even other funds. Mixed funds are designed to combine riskier products with lower-risk ones. 

In this way, the potential returns of riskier investments can be combined with the regular returns of stable products in a fund and mutually stabilise or offset. In the case of sustainable mixed funds, ESG criteria again play a decisive role in the structure of the fund portfolio.

Sustainable umbrella funds

Here, a fund invests in several investment funds at the same time, bringing together a larger number of investments under one roof. The spread reduces the risk, but, at the same time, the number of companies and projects increases. This also makes it more difficult to maintain an overview of the individual projects and their sustainable objectives and techniques. 

ESG ETFs

As the name implies, the selection of the individual investment items contained in an ESG ETF is based on the ESG criteria of Environment, Social and Governance. This is done either passively, for example by excluding companies, or actively via fund managers, experts and analysts. Although these are often more expensive, a higher sustainability requirement is often taken into account here.

However, ESG ETFs do not offer an actual measurable impact of their own investments. Therefore, anyone who places particular importance on transparency and verifiability may find it worthwhile to take a closer look at impact funds.

Sustainable thematic funds

In the case of thematic funds, the portfolio structure and the selection of investment items considers specific aspects, such as renewable energies, solar systems or reforestation projects.
 

Impact funds

Among sustainable investments, impact funds are those that make their objectives and their implementation not only transparent, but above all measurable. In addition to considering ESG criteria, impact funds are concerned with defining specific objectives and making their achievement visible and demonstrable for investors.

The fund assets often flow into the real economy and thus ensure that the investment capital is used in specific projects and thus makes a real impact.

The figures speak for themselves: demand for sustainable investment funds has been rising for years. The European market is experiencing double-digit growth rates for this type of investment – a segment that is growing faster than the entire European investment market.1,2 

The sustainable financial market is thus no longer just a niche for those who are passionate about protecting the environment, but has now proven its suitability for the masses. As already mentioned, companies with a certain sustainability requirement perform at least as well, if not above average, compared to conventional investment products.

Although much is promised in terms of sustainability, it is unfortunate that only very few providers can truly keep their promise. The fund rating system of the Finanztest 09/23 magazine, published by the Stiftung Warentest foundation, found that nearly one-third of the 934 funds have already failed to meet the minimum threshold - for example, the exclusion of fossil fuels, child labor, or controversial weapons.²  

However, with regard to the most widely used “sustainable” investment strategies, such a ratio is not surprising. 

Using exclusion principles, a provider can exclude companies from the portfolio that, for example, are actively involved in the destruction of ecosystems or in the production of weapons of mass destruction and therefore do not meet certain requirements. Such exclusions are enough to advertise a sustainable product – but such suppliers are still a long way from actual sustainability. 

For example, if the best-in-class approach is used, a supposedly sustainable financial product is created by investors investing in the cleanest of a group of oil companies: providers advertise a sustainable product, although returns play a significantly greater role with such investment items and the companies funded are far from achieving actual sustainability. 

The actual sustainability of financial products can thus be quickly disguised. If you as an investor are interested in a truly sustainable investment product, you should raise your standards in terms of sustainability criteria and consider impact investing: 

In the case of an impact fund that invests in tangible assets, for example, the investment capital flows directly into the real economy in the form of wind farms, solar parks or waterworks. Impact funds thus fund the expansion of renewable energies and provide you with detailed information on their specific sustainability goals, such as reducing carbon emissions. 

To this end, the fund defines a transparent and measurable threshold that specifies how many kilogrammes of pollutants are to be avoided by the production of sustainable electricity. However, since the production of renewable energy also produces harmful greenhouse gases, these emissions are also disclosed and included. This allows a fund to offer its investors a detailed overview of how it performs in relation to its own set objective.

In principle, the same rules apply to sustainable investment funds as to traditional funds: depending on the fund, risk, return and availability are in balance with each other, so that higher potential returns are also associated with a higher risk, for example. 

Sustainable equity funds and ETFs are typical examples of this. As their performance is linked to the development of stock market prices, there are often higher potential profits here than with other products. At the same time, however, there is always the risk of falling prey to a price crash. In addition, the aspect of sustainability is not really transparent and demonstrable in such products. 

But there are funds that deliver good returns. If, for example, you invest in an open-end, well-diversified impact fund, you can take advantage of the opportunities offered by the energy transition and thus secure solid returns.

The risk here is significantly lower, as tangible assets are less exposed to strong price fluctuations. At the same time, they ensure that your portfolio is well-diversified. 

In summary, you do not have to apply any fundamentally different standards in terms of return and risk for sustainable funds than for traditional investment products. If you know the three principles of return, safety and availability, you are also well-positioned when it comes to the risk assessment and classification of sustainable funds.

The first step in selecting a financial investment is always to know your financial situation and to critically assess it: 

• Investment capital: How much capital is available to you and how much is added on a regular basis?
• Would you like to invest money as a one-off or at regular intervals?

Once you have clarified these aspects, the following conditions must still be taken into account when selecting a financial investment:

• Risk appetite: How do you feel about risk? How much risk does your situation allow? What is the risk spread, if you already have some money invested?
• Timeframe: What stage of your life are you currently in? Over what period of time can you do without a certain portion of your investment?
• Active vs. passive: How much time and/or money would you like to invest in your investment, in addition to the investment amount? Do you want your investment to be actively managed so that you don’t have to manage it yourself? Or do you enjoy dealing with stock market prices and market developments, so that you also like to manage your investments a little more?

If a particular topic is close to your heart, for example the environment, this can already steer the selection of your sustainable investment fund in a specific direction. Or you have the option of excluding certain assets or companies from the outset on the basis of your personal attitude in order to get closer to the investment that is right for you using the exclusion process.

If you take the preceding aspects into account, the range of possible investments can already be narrowed down considerably. If, for example, you are only considering an active sustainable investment fund and you are reluctant to take high risks, you might consider a sustainable real estate fund.

Experience has shown that open-end real estate funds offer a high level of safety and are managed by fund managers whose task it is to ensure that the product provides continuous good performance. 

If you have also decided in step two that you want to use your capital to combat climate change, you will end up with a combination of manageable risks and real impact with tangible asset impact funds. 

Based on this principle, you can find out which aspects that are decisive for you are in which product in order to delve deeper into the research with this knowledge.

Take your position as an investor seriously and review the sustainability criteria of your fund and the impact of your investment so far in a targeted manner and regularly: What effect does my investment have on the real economy? Where exactly does the capital go? Is the sustainable impact of the investment made measurable – and if so, how? 

If answering these questions reveals critical weaknesses in the product, you can use your voice to drive sustainable change.