Sustainable ETF Investment: How to Be a Responsible Pension Investor in Germany

Does negative investing make a big difference?

Negative investing, i.e., not investing in some companies as an individual, does not make that much of a difference. For example, you may not like personal firearms, and maybe 90 % of Europeans don't want them either. But that is not enough to kill the industry or even make a significant dent.

Positive investing works! Do it if you have a good nest egg.

In contrast, positive or impact investing can be more impactful. I do some positive investing. For example, I like two companies in particular. They are industry leaders in green innovation. Sif Group builds pilings for windmills. They make them ever larger to help wind energy become cheaper and expand the sea area where they can be placed. Soon, we will see 18-megawatt windmills, each powering over 200 cars! They license their technology now in Asia and the US. Another company is Avantium, which is involved in making biodegradable plastics in a new way. But it is a much earlier stage company and hence more risky.

I am not advising you to buy these but to give you examples I know well.

Am I making a huge difference? No. But if there are 10.000 people like me, this will make a substantive difference. These companies will have cheaper capital and can grow faster. Anyhow, it feels good, and it can be nice to understand what is happening with some of your money.

I can do that also as I am older and have accumulated an ample nest egg. So don't feel guilty if you are not there yet. A few hundred euros will not make a difference, so don't worry. The time will come when you will have an opportunity to make more of a difference if this is what you want.

It is an important enough task to focus on building your pension for yourself and your family.

Does responsible investing make financial sense?

Yes, it does, up to a point. Avoiding the worst ESG offending sectors like firearms and tobacco and underweighting the worst performers in ESG terms can lead to some outperformance. With the increased focus on sustainability, these companies are often more forward-looking and in higher growth areas. In that vein, we do offer options at Pensionfriend where we feel they have a chance to outperform. We don't think the data is hard enough to be reasonably sure, but we think our ESG options are not a bad choice and might well perform better than the non-ESG versions.

Note: ESG criteria, or Environmental, Social, and Governance criteria, are factors used to evaluate an investment's sustainability and ethical impact. It assesses how a company or organization performs regarding environmental impact, social responsibility, and corporate governance practices.

Some evidence doubting the beneficial results can be found in the paper “Socially Responsible Investing in Good and Bad Times” by Bansal, Wu, and Yaron (2021), where they found that stocks with a high sustainability score outperformed those with a low rating during good economic times and inversely in the bad economic times.

Some evidence supporting the beneficial results can be seen in the following graph, which shows that over the last 10 years, the ESG large companies'  index has outperformed the overall index by 0,35 %. The ETF, which we recommend as part of our Global Green Outperformance portfolio, has existed since 2019. 

The following graph shows more evidence of the scope of outperformance of a green portfolio. It shows a backtest of the Global Green Outperformance portfolio against the MSCI World Index between September 2012 and September 2022 with an initial investment of 100 € and no additional contributions:

Our Euro Green Outperformance Portfolio excludes companies not compliant with decarbonization targets and other minimum standards for an EU Climate Transition Benchmark. It is invested mainly in large capitalization companies, focusing on Europe and the US. Historically, the Euro Green portfolio outperformed the MSCI World Index (EUR Hedged) by 0,65 % annually.

Discover your sustainable investment options with the Pensionfriend Pension Plan

What types of sustainable ETF investments are there?

The European Union (EU) has taken specific legislative actions; namely, it has adopted “The EU Sustainable Finance Disclosure Regulation (EU SFDR)” to encourage and regulate sustainable finance. 

According to EU legislation, ESG products are grouped into Articles 6, 8, and 9 compliant. Let us call them “agnostic,” “OK,” and “targeted positive” investments:

To support positive investing, the European Union has adopted the EU Taxonomy Regulation (EU TR) that came into force on January 1, 2022. It is a classification system¹ that identifies six EU environmental objectives:

• Climate change mitigation

• Climate change adaptation

• Sustainable use and protection of water and marine resources

• Transition to a circular economy

• Pollution prevention and control

• Protection and restoration of biodiversity and ecosystems

Starting on January 1, 2023, the taxonomy regulation will be integrated into the disclosure requirements of the SFDR. Indeed, investors should be able to find the relevant information on the websites of their investment product providers.

But let us be honest: if you dive deeper and try to understand what is under the hood, it isn't easy to understand this legislation, even with a PhD and half a law degree.

Let me give you an example. My favorite company mentioned above, SIF Group, the windmill pile company, is not entirely clean. Sure, governance is sound. Focus on employee safety is good. They try to be Co2 positive! But they occasionally still construct pilings for oil drilling. And indeed, can they guarantee that the steel used has absolutely no pollutants? No. So, they are massively innovative in the windmill space. Still, I could not tell you if they are compliant with any of the EU categories – they are compliant with various United Nations ESG principles – and frankly, that is not what I look at.

Indeed, there are very few funds in the Article 9 category, and all the fewer as the EU has tightened its criteria. In other words, the bar is so high that little is left to invest in.

In addition, it is also not at all clear if your investments in such general ETFs make sense. For example, the circular economy category includes recycling companies, such as waste management companies. I don't think it makes much sense to prefer such a sector as a whole. Their growth is driven by government regulation--and your vote--not by your investment. I would instead focus on an innovative company, provided there is one in the sector, and invest in it as that would make both financial and environmental sense, rather than just investing in the sector.

Indeed, the returns from impact investing in sectors tend to be slightly lower than the market average. In a study by the University of California, the median impact fund had a median internal rate of return of 6,4 %, compared to 7,4 % from non-impact-seeking funds.² 

At Pensionfriend, we offer some SFDR article 9 compliant funds that have shown strong annual returns and outperformed their benchmarks during the last decade. Still, we do not recommend them as this outperformance is more likely than not to be eroded because of the high cost charged. One of our main criteria when selecting the funds for our portfolios is keeping the cost as low as possible. In any case, you can easily find the 37 funds compliant with Article 9 SFDR here.

We will keep you posted when we have specific Article 9-compliant funds we can recommend.

¹ Please note that the taxonomy regulation does not cover the social and governance parts of the ESG.