Demystifying the greenness of funds

When you seek advice from your advisor on which fund to invest in, don’t be surprised that you’ll be asked questions like “What is your sustainability preference?” or “What is your minimum requirement for taxonomy alignment?”

You may be wondering what these terms are about. Advisors are trying to understand the sustainability preferences of clients, because the EU regulators aim to protect investors by requiring more transparency and comparability from the sustainability features of funds.

What is Taxonomy alignment?

To put it simply, taxonomy alignment is analogous to the nutrition facts on a bag of almonds. Instead of showing you how much energy, fibre, and protein they provide, the “nutrition facts” of a fund – “Taxonomy alignment” – show the portion of the fund invested in “green activities”, in other words, economic activities that qualify as environmentally sustainable under the EU Taxonomy Regulation.

The EU Taxonomy is a classification system, establishing a list of environmentally sustainable economic activities. It establishes six 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

Currently, the technical screening criteria for the first two climate change objectives do in effect cover more than 100 economic activities in nine macro sectors, including manufacturing, energy, water supply, sewerage, waste management and remediation, transportation, real estate, forestry, as well as information and communication.

It is worth noting that industries with low emission by nature such as retail, healthcare, or finance are not on the list. Instead, the Taxonomy targets sectors with high climate change mitigation/adaptation need and potential, such as energy, building, and manufacturing to incentivise investments geared towards achieving climate neutrality.

To be Taxonomy-aligned, an economic activity of a company needs to:

• make substantial contribution to an environmental objective,
• do no significant harm to other environmental objectives that the Taxonomy establishes, and
• comply with minimum safeguards with regards to human rights, including workers’ rights, bribery/corruption, taxation, and fair competition.

Technical screening criteria

In short, the criteria for Taxonomy alignment are stringent. At this point, the Regulation has established the technical screen criteria for climate change mitigation and climate change adaptation, while the technical screen criteria of the remaining four environmental objectives are still under development.

How do we manage?

Internally, the “nutrition facts” – i.e. the Taxonomy alignment of our funds – are displayed in the ESGenius App, which allows the user to constantly monitor and manage the “greenness” of our portfolios.

The chart below demonstrates the Taxonomy alignment of the funds ERSTE WWF STOCK ENVIRONMENT and ERSTE GREEN INVEST. Both funds focus on making a positive impact on the environment. ERSTE WWF STOCK ENVIRONMENT invests in companies with environmental technologies that have a positive impact on the environment, with a focus on companies that are primarily active in the areas of water treatment and supply, recycling and waste management, renewable energy, energy-efficiency, and mobility. ERSTE GREEN INVEST additionally invests in areas of transformation and adaption.

As can be seen, the estimated Taxonomy alignment for these funds stood at 49% and 39% as of March 2023, respectively. In comparison, MSCI World Index has an estimated Taxonomy alignment of about 5%.

Why not 100% Taxonomy-aligned?

One might expect environmental theme funds to have an extremely high Taxonomy-alignment, say, close to 100%. This may not be desirable nor feasible for several reasons. First, the EU Taxonomy contains activities of selective industries with specific criteria. Companies themselves may have diverse business segments, not all of which may fall into the Taxonomy-aligned categories. Indeed, a close-to-100% Taxonomy-aligned portfolio may be achieved by, for example, investing solely in pureplay renewable energy companies. However, the benefits of diversification to mitigate risk could well be significantly compromised.

Second, technical screening criteria are established with a best-practice approach to technologies within that industry to incentivize companies to achieve said levels. Therefore, it is normal for the current Taxonomy alignment of companies to be low in general since companies are just embarking on their journey to get closer to the high bar that regulators set.

Lastly, data coverage is a factor of alignment since some of the invested companies are not covered by data providers or not obliged to report their Taxonomy-relevant sales figures.

Conclusion

After all, the “nutrition table” aims to provide information. Ultimately, it is up to investors to use such information and take their own decisions which suit them best. Selecting a fund is a matter of both individual taste of sustainability and considerations of other important factors including performance, sector diversification, Sharpe ratio, risk appetite, and investment horizon.

Advantages for the investor

• Broad diversification in companies of the global equity market.
• Investment into companies with above average ESG characteristics.
• Active stock selection, based on a predefined selection process with a strong environmental focus.
• Opportunities for attractive capital appreciation.

Risks to be considered

• The net asset value of the fund can fluctuate considerably.
• Due to the investment in foreign currencies, the fund value can fluctuate due to changes in the exchange rate.
• Capital loss is possible.
• Risks that may be significant for the fund are in particular: credit and counterparty risk, liquidity risk, custody risk, derivative risk and operational risk. Comprehensive information on the risks of the fund can be found in the prospectus or the information for investors pursuant to § 21 AIFMG, section II, “Risk information”.

For further information on the sustainable focus of ERSTE GREEN INVEST as well as on the disclosures in accordance with the Disclosure Regulation (Regulation (EU) 2019/2088) and the Taxonomy Regulation (Regulation (EU) 2020/852), please refer to the current Prospectus, section 12 and the Annex “Sustainability Principles”. In deciding to invest in ERSTE GREEN INVEST, consideration should be given to any characteristics or objectives of the ERSTE GREEN INVEST as described in the Fund Documents.

Advantages for the investor

• Broad diversification in companies of the environmental sector with little capital investment.
• Support for WWF’s environmental protection programs by Erste AM.
• Opportunities for attractive capital appreciation.
• The fund is suitable as an addition to an existing equity portfolio and is intended for long-term capital appreciation.

Risks to be considered

• The price of the fund can fluctuate strongly (high volatility).
• Due to the investment in foreign currencies, the net asset value in Euro can be negatively impacted by currency fluctuations.
• Capital loss is possible.
• Risks that may be significant for the fund are in particular: credit and counterparty risk, liquidity risk, custody risk, derivative risk and operational risk. Comprehensive information on the risks of the fund can be found in the prospectus or the information for investors pursuant to § 21 AIFMG, section II, “Risk information”.

For further information on the sustainable focus of ERSTE WWF STOCK ENVIRONMENT as well as on the disclosures in accordance with the Disclosure Regulation (Regulation (EU) 2019/2088) and the Taxonomy Regulation (Regulation (EU) 2020/852), please refer to the current Prospectus, section 12 and the Annex “Sustainability Principles”. In deciding to invest in ERSTE WWF STOCK ENVIRONMENT, consideration should be given to any characteristics or objectives of the ERSTE WWF STOCK ENVIRONMENT as described in the Fund Documents.

For a glossary of technical terms, please visit this link: Fund Glossary | Erste Asset Management

Legal note:

Prognoses are no reliable indicator for future performance.