Sustainable investments – from niche to mainstream
Niche, mainstream, supertrend – sustainable investment is on everyone’s lips these days. The number of available ESG funds1 has grown exponentially, especially in the last three years. Providers that do not yet have ESG investments on offer are increasingly operating at a competitive disadvantage. Credit Suisse Index Solutions was one of the first providers to launch a whole range of sustainable index funds.
For many investors, the question is no longer whether, but how best to invest in ESG funds – and there are almost as many opinions on this as there are investors. However, some requirements are common to all investors: ESG index funds should not deviate too much from the parent index, should have a similar risk profile, and should offer a return at least as good as the standard index. Credit Suisse Index Solutions has always been committed to these requirements, and relies on the ESG Leaders approach from MSCI.
Companies that consider environmental, social and long-term business aspects in their operations often achieve better results than the wider market. This is hardly surprising, since they have a more advantageous risk profile than controversial companies due to their responsible use of a wide variety of resources. As a consequence, they often perform better on the stock market. This was not always the case. In the past, mainly quarterly sales and profit figures were rewarded. Many investors would have fully agreed with the argument, that the inclusion of ESG criteria reduces returns. However, extensive studies have shown that sustainable investment strategies often outperform traditional products in terms of return and are many times less risky in the event of market corrections. The current generation of investors has therefore recognized the potential of sustainable investments. The number of ESG-based funds and their assets have increased sharply, especially in the last three years.
Credit Suisse Index Solutions offers a whole range of sustainable index funds that cover a broad spectrum of ESG investments. The ESG Leaders indices from MSCI serve as a basis for our products. According to our evaluations, these best meet investors’ requirements in terms of risk/return profile and tracking error against the parent index, while consistently applying ESG criteria.
MSCI as a leading provider of ESG data
With a team of over 200 analysts who continuously evaluate more than 7,500 companies, MSCI has developed a transparent, objective and quantitative evaluation model that reflects the sustainability profile of companies as accurately as possible. The MSCI ESG Leaders indices are compiled on the basis of this high-quality data. These broadly diversified indices cover a large number of regions and have a comparable risk/return profile to their respective parent index. This is mainly due to a best-in-class index methodology that leaves industry weightings unchanged. Only securities that have successfully undergone a multi-stage selection process are included in the MSCI sustainability indices:
- In a first step, companies with significant income from controversial activities or business practices (e.g. arms trading) are systematically excluded.
- The remaining companies are subject to a detailed analysis based on publicly available data. This analysis finally results in the MSCI ESG rating.
- The top 50% of companies that received the ESG rating are then included in the ESG Leaders Index. To avoid sector distortions, this evaluation is conducted separately for each sector. This reduces the tracking error against the underlying parent index.
A comparison of the performance of ESG Leaders indices against their parent indices shows that almost all ESG indices have historically outperformed the parent index. In Emerging Markets in particular, there is a much better performance.
One exception is the United States, which is the only region in the MSCI World ESG Index not to outperform its non-ESG equivalent. This is mainly due to large technology companies such as Facebook and to the weapon industry. They are classified as unsustainable by MSCI but have an above-average historical performance.
It is not possible to invest in an index. The index returns shown are not the results of actual trading in investable assets/securities. Investors that pursue a strategy similar to an index may achieve lower or higher returns and must take the associated costs into account.
Historical performance indications and financial market scenarios are not reliable indicators of future performance.
In contrast to the slight underperformance of the MSCI World ESG Index in the past, the MSCI All Country World ESG Index (the current combination of 12% MSCI Emerging Markets ESG Index and 88% MSCI World ESG Index2 as of the end of November 2019) has narrowly outperformed the benchmark index, partly due to the effects mentioned above.
In addition to comparing ESG indices with their traditional counterparts, many studies3 have been able to demonstrate the positive correlation between a company’s sustainability orientation and its financial performance. Credit Suisse therefore has a long tradition of aligning various investment strategies with sustainability. Back at the turn of the millennium, Credit Suisse was one of the first companies to sign the UN Global Compact, the world’s largest agreement on responsible corporate governance. Since then, the product range of sustainable funds and index funds has been steadily expanded. Assets invested in ESG index funds by Credit Suisse Index Solutions have now grown to over CHF 4 bn.
We expect demand for ESG based index funds and green bonds to remain strong in the future and will therefore continue to expand our product range. Our clients always benefit from the same management fee as for our standard products.
Equity risk: Equities are subject to market-, sector-, and company-specific risk which may result in price increases/ decreases.
Investments in illiquid assets: When investing in securities which are not traded on exchanges or on regulated markets, it may be difficult to readily sell such securities. Moreover, there may be contractual restrictions on the resale of such securities. In addition, when investing in futures contracts or options, such instruments may also be subject to illiquid situations when market activity decreases or when a daily fluctuation limit has been reached. Most futures exchanges restrict the fluctuations in futures contract prices during a single day by regulations referred to as “daily upper limits”. When the price of a futures contract increases or falls to the maximum limit, the investor may be prevented from promptly liquidating unfavourable positions, which may result in losses.
Alternative funds risk: Alternative funds can invest in securities that have limited liquidity, including non-transferable assets. These might include, but are not limited to, senior loans, insurance bonds, derivatives contracts (both exchange-traded or over-the-counter), commodities. Some of these funds may have positions that include leverage.
Hedge funds risk: Hedge funds are not suitable for all investors as they can involve speculative strategies. Investments in hedge funds are not guaranteed and therefore the value of an investment can rise and fall. Hedge fund investments carry additional risks such as those associated with limited liquidity, the use of leverage, short sales, derivative instruments, futures, options, emerging markets, illiquid investments. Investment in hedge funds can result in an entire loss of the capital invested.
FX risk: FX trading is subject to currency- and leveraging-risk and could involve a significant risk of loss of capital.
Market risk: The price and value of investments and any income that might accrue could fall or rise or fluctuate. You may also lose the total sum that you have invested. If any of the markets on which any of the underlying investments in the fund is listed were to perform negatively, an underlying investment which has a high correlation to its market will generally move in tandem, irrespective of its fundamental strength. This in turn will affect the performance of the fund. Market risk is inherent in all funds which are populated with quoted investments.
Liquidity risk: This is the risk of not being able to sell your investment at short notice. Regulated mutual funds usually trade on a daily basis, thereby offering good liquidity. Should there be a high number of redemption requests at any time owing to a desire by large numbers of investors to liquidate their holdings, the fund may suspend liquidations or offer reduced liquidity in order to reduce the impact of having to sell significant amounts of the underlying investments in order to meet the requests.
Cash risk: Where a fund holds at any one time a substantial proportion of its assets in cash, near-cash, or money-market instruments, it might not participate fully in a rise in market values of the asset classes the fund would otherwise invest in.
Underlying investment risk: This is the risk of any of the underlying investments in a fund underperforming for any reason. By definition, such risk attaches to each of the underlying investments in all diversified funds. Underperformance by one or more of the underlying investments will negatively affect the overall performance of the fund, although the relative impact of each individual underperformance will be determined by the extent of the fund's diversification.
Leveraging risk: A fund may maintain net open positions in securities, currencies, or financial instruments with an aggregate value in excess of such fund’s net asset value (leverage). Such leverage presents the potential for significant profits but also entails a high degree of risk including the risk that losses in excess of the amount invested will be sustained. Even where a fund will not be leveraged, certain transactions may give rise to a form of leverage if the fund may borrow funds and/or employ financial instruments and techniques with an embedded leverage effect. The consequence of the leverage effect is that the value of a fund’s assets increases faster if capital gains arising from investments financed through leverage exceed the related costs, notably the interest on borrowed monies and premiums payable on derivative instruments. A fall in prices, however, causes a faster decrease in the value of the fund’s assets. In extreme cases this may result in an individual fund becoming worthless. In any instance the liability of each shareholder is limited to the amount invested in the relevant share class.
Emerging markets risk: Investments in emerging markets are generally associated with higher risks. These include political risks, economic risks, credit risks, exchange rate risks, market liquidity risks, legal risks, settlement and market risks. Emerging markets have one or more of the following characteristics: a degree of political instability, a relative unpredictability of financial markets and economic development, a financial market that is still in the development stage, or a weak economy.