Investment motivations are being ignored in ESG

We should stop arguing over how a sustainable investment should look and start thinking about how financial performance, value-alignment or impact can be realised, say Florian Heeb and Julian Kölbel

In 2009, Simon Sinek held one of the most influential TED talks ever. He argued that, while most people focus on the what and the how, successful leaders start with the why.

Lately, there has been a lively debate on the what and how of sustainable investing – several asset managers have been targeted by greenwashing allegations. DWS’s share price plunged recently after regulators in the US and Germany confirmed they were investigating claims it had overstated its application of sustainability criteria. Last year, Deka Bank faced a legal challenge for allegedly overstating the impact of some of its investment funds. Both Deka and DWS deny the accusations. (RI note: Deka Bank has removed its impact calculator, but slammed what it called “a legal dispute based on petty arguments on questions of advertising law”)

Clearly providers need to be more careful about how they describe their products and services, but the bigger question is: what is the underlying promise of sustainable investing?

Not being clear about why we want to invest sustainably leads inevitably to confusion. For example, sustainable investment funds often contain oil stocks, based on the rationale that these companies perform best on ESG criteria within their industry. Many would argue this is greenwashing because burning oil is causing climate change. So, how can a fund be called ‘sustainable’ if it contains unsustainable companies? Likewise, a fund that excludes fossil fuel stocks may offer good conscience to climate-aware investors but do nothing to stop the burning of fossil fuels. How can a fund be called ‘sustainable’, if it does not contribute to making the economy more sustainable?

Without distinguishing between these objectives, it is unfair to make greenwashing accusations. It is like complaining that a sports car does not have sufficient cargo volume or that a truck does not look elegant

Both concerns have merit. But they presume different objectives behind an investment. Without distinguishing between these objectives, it is unfair to make greenwashing accusations. It is like complaining that a sports car does not have sufficient cargo volume or that a truck does not look elegant. Also, when assessing a client’s sustainable investing preferences, it is not enough to ask whether clients want to invest sustainably. It is essential to understand why they want to invest sustainably.

Based on our research and conversations with many different investors, we suggest differentiating between three major objectives: financial performance, value alignment and impact. These objectives are not always compatible, and they lead to different implications for the what and how of sustainable investing.

Financial Performance

Some investors want to reduce their risks by integrating sustainability information into their investment decisions. Alternatively, investors seek exposure to companies operating in sustainable industries to increase future returns. In both cases, the objective is to optimise financial performance. The most straight-forward approach to pursue this is ESG integration, where environmental, social, and governance factors are considered in service of delivering better returns. Under this aspect, no one should be surprised if a ‘non-sustainable’ company is in the portfolio, as long as it delivers sound investment returns.

Value Alignment

Some investors want to be invested only in firms that are consistent with their personal values. In other words, they do not wish to profit from industries or business practices that they find repugnant. So their objective is to align their investments with their values – irrespective of whether this leads to a better world or not, and without concern for return implications. In this case, simply excluding unwanted industries from the portfolio will do the trick. The fact that, as a result, other investors will hold larger shares of the excluded companies is irrelevant, because the objective is to align the personal portfolio with personal values. In our experience, people identify with ‘their’ investments quite a bit.


Finally, some investors want to have real-world impact with their investments. Such investors want to use their capital and influence to help make the world a better place.

Doing so requires a mechanism through which investments translate into real-world change. For example, using shareholder votes and engagement dialogue to convince the dirtiest oil companies to improve their environmental practices; or by investing in young companies that tackle global challenges but struggle to attract sufficient capital. It is important to realise that there can be an explicit trade-off between impact and financial performance – high-quality engagement, for example, costs money. And investments into impactful start-ups bear substantial risks. But when the objective is impact, those concerns are secondary. The primary concern is whether an investment delivers additional change, i.e., change that would not have happened without the investment.

There Ain’t No Such Thing as a Sustainable Investment

Given these different objectives, we should stop arguing how a sustainable investment should look. We should start thinking about how the objectives of financial performance, value-alignment and impact can be realised. Investment products are unlikely to meet all objectives at once. Of course, it is possible to create an all-rounder, but it is a bit like combining a pick-up truck with a sports car: it will drive, but it won’t win races and it probably won’t be used at construction sites, either.

Everything starts with understanding why clients want to invest sustainably. Under the EU’s amended MIFID II regulation, wealth managers and banks will be required to ask clients about their sustainable investment preferences. In addition to asking whether clients would like to invest sustainably, advisors should find out why clients are interested in sustainable investments. With this information, advisors can avoid recommending products that are in some way sustainable, but ultimately lead to disappointment because they do not match the client’s underlying aims. Instead, advisors can educate clients about the trade-offs that exist within sustainable investing, and pick products that deliver on specific objectives.

Product developers will also find it easier to focus on specific objectives, rather than on a vague notion of sustainability. Even when combining different objectives, it is helpful to be explicit about the trade-offs. This extends to ESG metrics and ratings – an essential input to many sustainable investment products. ESG ratings usually provide one aggregated score indicating how ‘sustainable’ a company or a fund is; yet, the ‘why’ behind these scores remains vague. Even experts struggle to pinpoint what ESG ratings measure precisely: financially material risks of companies? The moral soundness of a company’s business practices? Or how a company affects people and the planet?

Having a clear view on objectives will help to inform what and how things are measured.

Finally, sustainable investing labels and ratings should perform their assessment in three separate dimensions. Is a product likely to enhance financial performance by integrating sustainability information? Are its holdings aligned with specific sets of values? Does investing in it have a real-world or impact?

Being clear on which questions a label answers, strongly increases its use for investors seeking suitable products.

Flight to Quality

The sustainable investing industry is maturing. Sustainability has arrived on the main stage in financial markets; almost everything is in some way marketed as sustainable now. After an intense phase of mainstreaming, we expect a drive towards quality in the coming years. This requires a more differentiated view on what quality means. For this, it is essential to be clear about the objectives of sustainable investing.

Florian Heeb is a Researcher at the Center for Sustainable Finance and Private Wealth at the University of Zurich


Julian Kölbel is an Economist and Environmental Scientist at the Center for Sustainable Finance and Private Wealth at the University of Zurich