We want many things from our investments. But above all, an investment needs to be sustainable – in the broadest sense of the word.  If the instrument you’re investing in isn’t going to be there in a few years when you need it, there is a major problem.  Recent changes in Europe known as SFDR are designed to help investors understand how sustainable their investments are.

But what do we mean by sustainable? It quickly gets complicated.

For example, a startup focused on the circular economy might be environmentally worthwhile, but a financial basket case.

In contrast, an oil and gas company might possess the key skills needed to design, construct and operate an offshore wind farm – but also produce hydrocarbons.

Just as with judging investments in general, it isn’t easy to neatly categorise investments as sustainable in black and white terms.

As we’ve explained elsewhere, environmental, social, and governance-driven (ESG) investing is a work in progress. The standards are still being developed, and what constitutes an ethical approach for one investor can be very different to the choices of another person.

SFDR provides a framework

The EU has attempted to bring some order to the situation with the introduction of the Sustainable Finance Disclosure Regulation (SFDR).  Under SFDR, sustainable basically means an investment contributing to an environmental objective, a social objective, and following good governance practices (there’s a link to the full definition at the end of this article).

As a result, many investment funds will fall into one of three categories, depending on what information they give about the sustainability of their investment approach.

What’s more, advisors in Ireland now have a duty to consider sustainability when advising their customers on investment funds.

We’ve explained each category below.

Article 6 funds

First, there are Article 6 funds.  Such funds have no specific emphasis on sustainability in their investment process.

Of course this doesn’t mean that all their investments are unsustainable.  Rather it means that they incorporate sustainability into their overall investment decision process.  Such funds may hold investments in sectors many would regard as questionable from an ethical or social perspective, such as tobacco or defence.

But an Article 6 fund is not automatically unsustainable, or unethical.

In practice any fund manager worth their salt considers the long-term viability of their investment decisions.  If a company is likely to face significant negative impact from, say, a warming planet, then that is clearly (at the very least) a valuation factor in the investment process.

To take another example, as we wrote here during COP26, many investment managers refused to invest in Deliveroo last year because they deemed its labour practices unsustainable.

But that does not automatically mean that this was an ethically-driven decision. For many fund managers, no doubt it simply arose from a dispassionate look at the prospects of the company.

Many of the most popular funds in Ireland will fall into this category.

Article 8: light-green funds

Secondly, there are Article 8, so-called light-green funds.  Article 8 funds “promote environmental or social characteristics, and… invest in companies that follow good governance practices”.

In plain English, this means that environmental, social and governance criteria are more than a happy by-product of the fund’s investment process.  Instead, there is a positive emphasis towards them.

Irish Life’s MAPS range and New Ireland’s Prime funds fall into the Article 8 category.

Article 9: dark-green funds

Lastly, are Article 9, so-called dark-green funds.  For dark-green funds, sustainability is the investment objective.  The standard is high: the investments must contribute to an environmental objective, track an EU climate transition reference benchmark, and “do no significant harm” in their activities.

Of the five major Irish life assurance providers (who operate most of Ireland’s pensions, for example), only Irish Life and Standard Life offer an Article 9 fund as of August 2022.

Investors – and advisors – need to see in technicolour

From an investor perspective, having only a handful of Article 9 funds to choose from is less of a concern that it might seem.

While such funds may offer very low sustainability risk, they are likely to introduce some new specific risks. They are often concentrated on particular industries, or reliant on government support or future technology development.

For these reasons, most investors in search of a balanced, yet sustainable portfolio, will tend to prefer a substantial exposure to Article 8 – and maybe Article 6 – funds alongside any dark-green investment holdings.

 

Source: Sustainable Finance Disclosure Regulation (pdf)

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