Sustainable investing is booming and a new approach should provide some clarity

Ratings are supposed to help, but they often contradict each other…

A separate industry has emerged to help investors make their selection: providers like Sustainalytics, MSCI and rating agency Standard & Poor's issue ESG ratings that are intended to make stock selection easier. These ratings are often based on publicly available data, company surveys and individual interviews.

Since everyone is gathering the same information, you might think that the ratings would turn out to be roughly the same. But a study by Credit Suisse Research Institute shows that the classifications often contradict each other. The most prominent example is Tesla: MSCI rates the electric car manufacturer as the best automotive stock as far as sustainability is concerned. But for FTSE, another ratings provider, Tesla is the worst in the class. Sustainalytics gives it an average ranking. One of the reasons underlying the divergent assessments is that MSCI primarily looks at the low-CO₂ cars Tesla makes, whereas FTSE focuses on the emissions produced by the company's factories.

Despite this, many fund providers rely on such ratings to put together sustainable funds. There is also a whole series of stock indices for sustainable investing. One of the best known is the Dow Jones Global Sustainability Index. This applies the "best in class" principle; hence the index includes Toyota, and even integrated oil giant Total.

Hubert Keller is not impressed by these ratings and indices. "These ratings tell you very little about how companies are positioned for the transition in climate policies required under the Paris Agreement," he notes. Avoiding steel manufacturers because steel production generates a lot of CO₂ is no way to go about things, in his view. "In fact, the companies that are major emitters of CO₂ but have a plan to fundamentally decarbonise their business model are the ones that have the potential to drive the transition to a net-zero emissions economy," he says. Lombard Odier has developed its own models to check whether a client portfolio is exacerbating the effects of climate change or if the client is compatible with the objectives set down in the Paris Agreement to limit the increase in temperature to two degrees.

Unclear ratings and a plethora of different sustainability strategies

Legislators have now got involved with the aim of creating greater clarity – but in Brussels, not in Berne. The European Union is working on a definition of which economic activities are considered sustainable and which are not. The end result is meant to be a consistent "taxonomy".

An activity will be counted as sustainable if it contributes to meeting six environmental objectives. These include, for example, limiting climate change, promoting the circular economy or the sustainable use of water. An economic activity that undermines one of these objectives counts as an exclusion criterion. One major bone of contention that is still outstanding is whether nuclear power should be treated as sustainable. France is in favour, while Germany is opposed.

Is sustainable investing worthwhile for savers?

"The taxonomy will probably become the standard for creating financial products for the EU," says Bruno Bischoff, Head of Sustainability at Credit Suisse. But as with ESG ratings, one drawback of the planned taxonomy is that it says nothing about whether a company is heading in the right direction. "The taxonomy is binary: either something is sustainable or it isn’t," comments Bischoff.

Still, the taxonomy should at least provide investors with guidance, for instance requiring funds to show the percentage of stocks they hold that do or do not meet the EU standard. "The EU taxonomy will become an important basis for environmental financial products, but there is still a long way to go until the data is available," notes Sabine Döbeli from Swiss Sustainable Finance.

The following question remains: is sustainable investing worthwhile for savers? Credit Suisse Research Institute reviewed a series of studies and came to an ambivalent conclusion: "We found virtually no compelling studies at all showing that ESG funds perform better over the longer term.” Of, course this also means that at least investing with a clear conscience does not penalise investors when it comes to performance. But keeping an overview of all the different approaches is bound to put a strain on investors' nerves.

This is a marketing communication issued by Bank Lombard Odier & Co Ltd (hereinafter “Lombard Odier”).
It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication.
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