Germany leads in clean energy and has a good environmental record in areas like recycling. Yet it remains a laggard in sustainable investing. Nina Röhrbein asks why

Germany has often been considered a pioneer in all things green ranging from clean energy to the recycling of waste. However, when it comes to investing according to environmental, social and governance (ESG) criteria, Europe’s biggest economy has some catching up to do.

According to Eurosif’s European SRI Survey 2010, Germany had €12.9bn in socially responsible investment (SRI) assets under management at the end of 2009, which equates to 0.8% of all German assets and 0.25% of all European SRI assets.

“In comparison, the UK has 80 times as many SRI assets, Italy 25 times, Denmark 20 times, Belgium 15 times and France four times,” says Joachim Böttcher, member of BankInvest Group’s SRI committee. “Germany also only has a handful of signatories to the UN Principles for Responsible Investment [UN PRI].”

This comes in spite of the introduction of a sustainability reporting obligation by the insurance supervision law (VAG) for Pensionsfonds in 2002 and for Pensionskassen in 2005.

Germany’s sustainability position can be attributed to the absence of an equity culture, with which sustainability is usually associated, and the lack of SRI knowledge among German institutional investors.

“Sustainable products aimed at pension funds are also only available sporadically,” says Michael Schmidt, managing director and CIO equities at Union Investment, which has €3.2bn in SRI assets under management.

Initially a few providers tried to place product ideas with strong environmental criteria, which deviated too much from the traditional methodology to convince pension funds, according to Böttcher.

“The more pragmatic, conventional SRI product offering, which is more suited to the pension fund system, is still missing today,” he says. “Despite the existence of sustainability banks such as GLS Bank, Ökoworld, Ökorenta and OecoCapital, and the efforts by German asset managers Allianz, DWS, Deka, LBBW and Warburg with regard to the provision of sustainable funds, concrete implementation of SRI has yet to take place or comes from foreign providers.”

However, Robert Haßler, CEO at Munich-based sustainability rating agency oekom research, believes that asset managers in Germany are very receptive to sustainability and that few offer no sustainable products at all. The reason for this, he says, is that they want to be prepared for the demand of sustainability-oriented private and institutional investors such as churches and foundations.

The most notable sustainable investors in Germany are church-based, well ahead of foundations, pension funds, banks and insurance companies, according to the November 2010 study ‘The Importance of Socially Responsible Investments for Institutional Investors in Germany, Austria and Switzerland - A Network Analytical Perspective - Reloaded’ by international strategy consultant Funds@Work, based in Frankfurt.

“The least sustainable investors are corporates, which paradoxically are the predominant beneficiaries of those investments,” says Murat Ünal, founder of Funds@Work. “While church-based investors naturally take sustainability very seriously from an ethical perspective, German pension funds lag behind their Nordic, Dutch and UK counterparts.”

Ünal estimates that only 2-4% of all German pension funds and 1-2% of corporate pension funds apply some form of sustainability criteria to their investments.

“Corporate pension funds are linked to the decision making of their sponsoring companies and are very reactive,” he says. “They do not tend to walk the talk just yet. Versorgungswerke - which are the pension funds for liberal professions - are more autonomous and therefore more prepared to integrate sustainability, while insurers come in last when it comes to their own investments.”

“With regard to sustainability pension funds are only slowly waking up from their deep sleep,” adds Haßler. “Few have been implementing sustainability in their portfolios for some time - most of them only started looking at sustainable products over the last year, probably as a result of the financial crisis and the growing awareness of the UNPRI. However, the big pension fund money has yet to enter the market.”

SRI approaches vary significantly between investors and differ significantly in their integration. However, negative screens, also known as exclusions, dominate and are particularly widespread among churches and insurers.

But the evolution from exclusions to the more positive, best-in-class approach has also taken place in Germany.

Pension funds and other sustainable institutional investors typically exclude armaments, pornography, child labour and other sectors fraught with reputational risks for the investor.

The reputation risks were highlighted by a German TV programme similar in nature to that of the Dutch Zembla last year, which revealed that many pension products, including Riester products, were invested in US defence firms, which manufacture controversial arms. But alcohol and tobacco are less of an issue in Germany.

According to the Funds@Work study, 84% of the 121 respondents - out of a screened universe of over 1,200 institutional investors in Germany, Austria and Switzerland - apply a negative screen, the simplest way of undertaking sustainability. The more sophisticated best-in-class approach is used by 61%. Combinations of the different approaches are far behind and the more sophistication the combinations require the further they lag behind.

“While 23% of respondents said they undertook engagement only, it is hardly noticeable at annual general meetings,” says Ünal. “The pooling of voting action, similar to the way the Swiss foundation for sustainable development Ethos undertakes it in Switzerland, has yet to take place in a similar fashion.”

“The best-in-class approach is quite popular for two reasons: first because it can help improve returns and second because it steers companies towards more sustainability,” says Haßler. “However, it is too early to say what SRI strategy will emerge as the favourite among German pension fund investors and to what extent they will adopt best-in-class concepts. While sustainability in Germany is often associated with the environment, the breach of labour rights and standards is just as important. Climate change is an unparalleled issue, which is more located on the risk/return side and which also appeals to the mainstream investor. Corporate governance receives attention particularly with regard to corruption and competitive distortion.”

While sole thematic fund investments are generally not considered to constitute an SRI approach, SRI thematic funds have lost their prevalence in Germany compared to 2007 - most likely due to the fact that one important provider strongly reduced its activity in the field during the financial crisis. Themed investments amounted to €3bn in 2009, equivalent to a market share of 23%. By contrast, in 2007, more than half of all sustainable assets under management were solely or in combination with other approaches covered by thematic funds, according to Eurosif.

Current discussions surrounding ESG among pension funds and Versorgungswerke are more about the introduction of engagement, says Ünal, rather than direct investments in sustainable assets.

Between 2002 and 2007, MetallRente Pensionsfonds applied a negative screen to its equity investments based on the principles of the International Labour Organisation (ILO) and the UN Global Compact initiative, as well as the UNA Trust criteria, which prohibits investments in companies that produce armaments, nuclear energy, tobacco and pornography.

In 2007, the negative screen was replaced by a best-in-class approach, which follows the Dow Jones STOXX Sustainability index, although it is active and based on its own SRI-related asset management. However, exclusions of companies in the military armaments, nuclear energy, pornography and tobacco sectors remain.

Union Investment has a dynamic best-in-class model, which allows companies to be included that excel compared to their competitors and that undertake particular sustainability efforts. The asset manager also engages with the companies in its portfolio, a function that over the last two years has been embedded within its corporate governance part.

Corporate governance, including proxy voting and remuneration, is a key issue for Union Investment.

“We focus very much on the board of directors and corporate actions,” says Schmidt. “The financial crisis and the corruption scandal at Siemens have moved the spotlight onto corporate governance and the controlling bodies because it is perceived to be able to function as part of an early warning system.”

According to the Funds@Work study, equities and corporate bonds are the asset classes used most when institutional investors invest sustainably, certainly also due to the similarity of the research process, as both are financing instruments of corporations who are at the core of the corporate social responsibility discussion.

Commodities and hedge funds are not bought by the sustainable investors of the study. “Speculative investments in commodities can have destructive ramifications and damage entire economies, as demonstrated by the conflicts in North Africa and the Middle East,” says Ünal. “Speculative investments in agricultural commodities create artificial demand for the products and drive their prices higher. As food expenditure takes up 50-60% of people’s incomes in some countries, this can cause entire economies to topple. Therefore, from a sustainability perspective, you would have to stay clear of such investments. Eventually, the commodity investments will also affect the investor’s equity investments, for example, in emerging markets or by creating a boomerang effect whereby in certain countries the environment will deteriorate and affect the companies’ operational setting, whose stocks investors are exposed to. Unfortunately, traditional investors still see it as a way to generate extra returns, which is why so many other products such as exchange-traded commodities (ETCs) and funds (ETFs) are created on the back of them.”

In SRI, institutional investors outside of Europe tend to invest globally, such as in the US or Japan. Emerging markets are still the exception, according to the Funds@Work study.
Mandate investments make up the largest part of German SRI assets with €6.6bn at the end of 2009, according to Eurosif. Mandates and mutual funds are behind the 16% growth in Germany’s SRI market since 2007, while structured products have decreased compared to previous years.

But the market is predicted to grow by 56% within the next three years, German financial providers told Eurosif.

Haßler compares sustainability to a steamboat that has slowly started its journey. “For risk and return purposes alone, institutional investors will become more sustainable in their investments,” he says. “Better quality criteria will also become more important among institutional investors who have so far only allocated a small proportion of their money to sustainability.”

But Heribert Karch, CEO at MetallRente, warns: “The German SRI space, which currently almost exclusively consists of institutional investors such as churches, foundations and non-profit organisations, will most certainly not be able to initiate sustainability without consensus between the social partners. That is why agreements on the sustainable investing of pension assets, similar to the ones that exist in the Netherlands and Switzerland, are also necessary in Germany.”