My finances, my projects, my life
June 18, 2024

Sustainable investment from A to Z

  Compiled by myLIFE team myINVEST November 21, 2022 1532

Sustainable investment, ESG, SRI: what exactly do these terms mean? Green or “responsible” investing is booming, but the terms used to talk about this are not always clear for the layman. myLIFE deciphers these concepts for you.

What is sustainable investment?

In recent years, issues related to sustainable development have been at the heart of political, economic and social considerations. Not to be outdone, the financial sector is now taking new factors into consideration in the design of investment strategies for individuals and wealth managers.

Sustainable investing means investing your money in companies and financial products which – in addition to traditional financial indicators such as risk assessment, potential returns, etc. – also include environmental, social and good governance criteria. These are the ESG criteria that are often talked about.

What are these ESG criteria?

While experts do not always agree on the list of criteria to be considered and the method used to measure them, they do concur that there are three aspects requiring consideration in a sustainable investment approach: “E”, “S” and “G” aspects.

    • “E” – environmental criteria: these assess the impact of the company on the natural world (greenhouse gas emissions, use of clean energy, waste management, preservation of biodiversity, etc.) as well as the impact of the environment on the company (physical risk and transition risk).
    • “S” – social criteria: these consider the influence of the company on people (respect for human rights, gender equality, health and safety, employee training, client and supplier relationships, etc.).
    • “G” – governance criteria: these are used to assess how the company is governed (respect for tax legislation, managers’ remuneration levels, independence of the advisory board, anti-corruption measures, implementation of internal controls, etc.).

Combining these ESG criteria means that a company’s level of sustainability can be gauged on the basis of its businesses and day-to-day management.

Socially responsible investment (SRI) means including these non-financial factors in investment decisions and portfolio management.

Socially responsible investment (SRI) – also called sustainable or responsible investment – means including these non-financial factors in investment decisions and portfolio management. The aim is to combine economic performance with a positive impact on society and the environment. myLIFE has regularly talked about the various aspects of SRI over the last few years.

Different SRI strategies

Investors and portfolio managers can implement several strategies or a combination of strategies to take account of the challenges of sustainable and responsible development when investing. For example:

    • the ESG leaders approach: this focuses on selecting companies that show the most respect for ESG criteria either within their sector (best in class) or across all sectors (best in universe), or those making the greatest effort to respect such criteria (best effort).
    • the exclusions approach: this consists of excluding investments in sectors or activities which are considered to be harmful for society or breach the investor’s convictions or certain international conventions (e.g. companies that do not respect human rights or are involved in armaments, tobacco, fossil fuels, or GMOs).
    • impact investing: this means investing in companies that intentionally target a measurable social or environmental impact (e.g. CO2 reductions, housing construction, tree planting, etc.).
    • the thematic approach: this targets companies active in certain sustainable development sectors (e.g. water management, renewable energies, combatting pollution, healthcare protection, etc.).
    • the active approach: this consists of being proactive within the company in which the investment is made by encouraging socially responsible behaviour (e.g. by exercising shareholder voting rights, engaging in dialogue with the management on ESG issues, etc.).

Some people prefer to invest in a cause that is dear to them while others opt for investments that support the companies with the most virtuous approach to sustainability. The principle of SRI is to choose a strategy that matches the targets and personal convictions of the individual investor. These investments may take different forms: buying units in investment funds that integrate ESG criteria, green bonds, social bonds, sustainable bonds or shares in companies committed to sustainable development, etc.

In 2016, the Luxembourg Stock Exchange created the world’s first exchange platform for green finance, which is exclusively dedicated to sustainable financial instruments: Luxembourg Green Exchange.

How do you recognise a sustainable investment?

To estimate whether an investment subscribes to a sustainable approach, it is useful to check out how investment products are made up or operate, or the selection criteria and investment policy used by the fund manager. An investor wishing to choose companies that comply with ESG and sustainability criteria can base their decisions on:

  • information provided in corporate annual reports, non-financial performance reports and Key Investor Information Documents (KIIDs) where this information is provided.

→ Watch out for greenwashing i.e. companies or investment products that give the impression of making a greater commitment to sustainable development than is actually the case.

    • scores awarded by rating agencies specialised in evaluating the ESG performance of companies: Sustainalytics, MSCI, ISS, etc.

→ The agencies use different methodologies to calculate their ESG scores and do not take the same factors into consideration. The results may therefore vary significantly from one agency to another making comparisons difficult.

    • labels awarded to companies and investment vehicles. In Luxembourg, the independent finance labelling agency LuxFLAG has developed thematic labels to identify sustainable investment products: Microfinance, Climate Finance, Environment, Green Bonds, ESG and Sustainable Insurance Product.

→ These labels may be useful but should not be the only criteria used to choose an investment vehicle. Many structures do not have a label but do include ESG criteria. On the other hand, it has to be said that the various European labels use a variety of different criteria and are not yet truly homogenous. It can all be a bit confusing.

For investors wishing to invest their money in activities with a positive impact on society and the environment, it has to be said that all this information is still rather unclear and far from homogenous. This is why new measures have been implemented or are being set up to establish a clearer common regulatory framework at the European level: the Sustainable Finance Disclosure Regulation (SFDR), MiFID II and the European Taxonomy. The aim is to improve the transparency of investment products, take the ESG objectives of clients into account, and harmonise and classify information related to sustainability.

Luxembourg Green Exchange

In 2016, the Luxembourg Stock Exchange created the world’s first exchange platform for green finance, which is exclusively dedicated to sustainable financial instruments: Luxembourg Green Exchange (LGX). Only products with green, social, sustainable or ESG characteristics are traded on the platform which brings together investors, asset managers and issuers operating in this field.

There are also various initiatives established by the Luxembourg government to encourage investors to move towards more responsible investing.

If you would like to start investing sustainably, look for support from experts who are able to help you select SRI investments that comply with your values and objectives. All investments entail some level of risk, whether or not they are sustainable. It is therefore always advisable to seek the support of an expert, particularly when starting out.