SFDR has become a cornerstone for guiding investors toward funds that supposedly align with their values. But how do these classifications impact the actual environmental and social performance of these funds?
In this analysis, we look at how funds classified under Articles 6, 8, and 9 perform across a variety of ESG factors, as well as examining how these factors relate to the funds' tracking error, offering insights into the trade-offs that may come with sustainable investing. More methodology detail can be found at the end of the article.
Net Impact Distributions Across SFDR Articles
When examining the net impact distribution, it's evident that Article 9 funds, which are required to have a sustainable investment objective, do generally exhibit the highest net impact. The histogram reveals a positively skewed distribution, indicating that most Article 9 funds are achieving positive impact, with a mean net impact of 65.12 basis points (BPS). This contrasts with Article 8 funds, which promote environmental and social characteristics but do not have a primary sustainability objective, showing a lower mean net impact of 18.97 BPS. Article 6 funds, which either do not integrate sustainability into their investment process or do so in a limited way, have a slightly negative mean net impact at -2.26 BPS.
So, Article 9 funds are (on average) delivering on their promise of positive societal and environmental impact. However, the broader distribution in Article 8 and 9 funds also highlights the variability within these categories, indicating that not all funds achieve the same level of impact, despite similar classifications.
Article 9 funds remain in the minority, while Article 8 funds significantly surpass Article 6 funds in number.
Environmental and Social Alignment and Misalignment
Article 9 funds show a higher percentage of revenue from products and services that align with environmental and social good compared to Article 8 and 6 funds. This is consistent with their higher net impact scores.
However, the plots also reveal that Article 9 funds, while generally better aligned with positive ESG outcomes, still exhibit some degree of environmental and social harm. This complexity underscores the challenges in achieving perfect alignment with ESG goals, even among funds with the most stringent sustainability mandates.
Article 8 funds, while better than Article 6 in terms of positive alignment, show more variability, suggesting that these funds encompass a wide range of approaches to ESG integration. The higher degree of misalignment in Article 6 funds is expected, given their less rigorous sustainability requirements.
Carbon, Waste, and Water Efficiency: A Deeper Look
The violin plots show that Article 9 funds, on average, are more carbon-efficient than Article 6 and 8 funds, with Article 8 funds slightly outperforming Article 6. This aligns with the expectations given the sustainability mandates of these classifications.
However, when it comes to waste and water efficiency, the analysis becomes more nuanced. Article 9 funds, despite their better carbon efficiency, do not always outperform Article 8 funds in waste and water efficiency. In fact, Article 9 funds show a wider range in water efficiency, with some funds consuming more water per $1M revenue compared to Article 8 funds. This may be attributed to the specific sectors these funds invest in, such as renewable energy, which, while beneficial for reducing carbon emissions, can be water-intensive. This is something we’ll explore in more detail later.
The analysis so far reveals that while Article 9 funds generally lead in terms of positive impact and carbon efficiency, the performance across other ESG metrics can vary significantly. Article 8 funds, which represent a broad middle ground, often show strong performance but with greater variability, reflecting the diverse strategies employed under this classification. Article 6 funds, as expected, lag behind in most ESG metrics, providing less of a focus on sustainability.
Slightly more technical - Tracking Error and Carbon Efficiency
Our first analysis focused on the relationship between tracking error and carbon efficiency across the three SFDR classifications.
As expected, Article 9 funds generally exhibit better carbon efficiency due to their stricter sustainability mandates. However, as tracking error increases beyond a certain point, the advantage of Article 9 funds begins to diminish, with Article 8 funds sometimes displaying better carbon efficiency at higher tracking errors – potentially down to lesser constraints on the fund’s constituents. Article 6 funds are consistently higher emitters than their 8 and 9 counterparts, for the most part at least.
As you can see, there are a significant number of Article 8 and 9 funds that are much more carbon intensive than the average Article 6 funds. This is where factual, quantitative data is required to uncover more detail about the real ESG impact, instead of relying on ratings alone.
Water and Waste Efficiency
Next, we examined water and waste efficiency. The relationship between tracking error and these two metrics provides further insights into the environmental impact of these funds.
The analysis of water efficiency yields an intriguing finding: Article 9 funds, on average, tend to use more water compared to their Article 6 and 8 counterparts. This result might seem counterintuitive at first, considering Article 9's focus on sustainability.
However, upon closer inspection, this trend can be partially explained by the higher allocation of Article 9 funds to renewable energy sectors, which, despite their environmental benefits, often require substantial water resources, particularly in technologies like concentrated solar power (CSP) and bioenergy.
Waste efficiency follows a somewhat similar trend, with Article 9 funds showing varied performance based on tracking error.
At first glance, this might seem surprising given Article 9’s strict sustainability mandates. However, this trend can be partially explained by the diverse range of sectors these funds invest in, including those with inherent waste challenges.
For instance, Article 9 funds often invest in industries like recycling and waste management, which, while focused on reducing overall environmental impact, involve significant waste processing activities. Additionally, the stringent reporting and transparency requirements for Article 9 funds may lead to more comprehensive and honest disclosures of waste generation, contributing to the higher observed figures.
Net Impact Analysis
Finally, we explored the net impact of these funds, which offers a more holistic view of their overall contribution to societal and environmental well-being.
When we remove +/- 200 net impact funds, we get a more refined view that’s easier to analyse.
The analysis suggests that as funds take on more tracking error, their ability to generate positive net impact varies significantly depending on their SFDR classification. Article 6 funds maintain a consistent but low net impact, reflecting their lack of focus on sustainability. Article 8 funds demonstrate a balanced approach, with some increase in net impact as they diverge from benchmarks, but without extreme variability. In contrast, Article 9 funds, which prioritise sustainability, show a more pronounced and variable response, highlighting the potential trade-offs and complexities involved in pursuing high sustainability goals.
For investors, these findings underscore the importance of considering how a fund's approach to tracking error might influence its sustainability outcomes. Article 9 funds may offer the greatest potential for positive impact, but with accompanying variability, while Article 8 funds may provide a more stable, though moderate, balance between financial performance and sustainability.
Interpreting Water use in Article 9 Funds
One of the most striking findings from our analysis is the higher average water usage among Article 9 funds. Given their strong sustainability mandates, this result may appear contradictory. However, it becomes more understandable when considering the types of industries these funds often invest in—especially renewable energy.
Renewable energy technologies, such as concentrated solar power (CSP) and certain bioenergy processes, are known to be water-intensive. CSP, for example, requires significant amounts of water for cooling purposes. Thus, while these investments are crucial for reducing carbon emissions and combating climate change, they may inadvertently contribute to higher water usage, illustrating the complex trade-offs involved in sustainable investing.
Broader Implications
While Article 9 funds generally align more closely with high sustainability standards, investors must recognise the nuanced challenges in achieving a balanced ESG profile. The trade-offs between carbon reduction and water usage, for example, highlight the importance of transparency in ESG reporting and the need for investors to look beyond headline metrics.
For fund managers, these insights emphasise the importance of carefully considering industry allocations and the potential environmental trade-offs involved. The pursuit of a single sustainability goal, such as reducing carbon emissions, should not overshadow other critical environmental factors like water and waste management.
Methodology note
We took every Article 6, 8 and 9 fund on our platform (over 8,000 funds) and examined the below ESG factors:
· Carbon efficiency (measured in tonnes per \$1M revenue)
· Water efficiency (measured in 1000m³ per \$1M revenue)
· Waste efficiency (measured in tonnes per \$1M revenue)
· Net impact (measured in basis points)
· Socially good/bad revenue
· Environmentally good/bad revenue
Where applicable, regression lines—linear and quadratic—were added to better understand trends. Outliers were filtered to ensure the data’s readability.
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