Security is the top priority for many customers. They do not want to invest their hard-earned money in unnecessarily risky investments and want to achieve an adequate return. There is no way around sustainability. ESG criteria have become indispensable for managing risk in portfolios.

A company can only be assessed holistically with sustainability aspects

Investment decisions have always been based on weighing up opportunities and risks. In order to be able to assess these, it is essential to take sustainability aspects into account.

Climate change, for example, has consequences for every company. They can be affected by production losses due to natural disasters (physical risks). But their profitability can also be affected by regulatory changes, such as an increase in the_{price of CO2}(transitory risks). It is therefore no longer enough to simply look at traditional financial indicators in order to evaluate an investment holistically.

The Californian energy supplier Pacific Gas & Electric (PG&E) provided an impressive example. In 2018, a fault in one of the company’s power lines triggered the Camp Fire, one of the most devastating wildfires in California’s history.[1] The fires claimed the lives of 86 people and devastated over 18,000 buildings covering an area of more than 1,500 square kilometers. PG&E was forced to file for bankruptcy due to claims for billions of dollars in damages. The disaster was caused by a lack of maintenance and failure to invest in vegetation control, combined with increasing drought due to climate change. Our sustainability analysis makes it possible to take such risks into account in order to evaluate companies more holistically.

The EB-ESG score: Evaluating sustainability even better

We have developed an innovative tool to analyze the sustainability of companies. The EB ESG Score compensates for the weaknesses of established sustainability ratings by combining the comprehensive, fundamental sustainability assessment of traditional ESG ratings with an AI-supported, news-based sustainability indicator.

The fundamental component takes into account the material ESG risks and opportunities, as well as how they are dealt with. Specific requirements and challenges of the respective industry are taken into account here. In addition, a news-based ESG score is calculated, which evaluates news in real time. This analysis includes several hundred thousand articles from thousands of global news sources. Thanks to the AI-based processing, current developments can be recognized and evaluated in advance. This enables a dynamic and timely assessment of a company’s ESG performance, allowing investors to act more quickly.

Lower portfolio risks thanks to sustainability

To show that investors with sustainable portfolios are systematically exposed to lower risks, we constructed three portfolios with different sustainability profiles. The 30 percent of companies with the best EB-ESG scores were sorted into a green portfolio, the 30 percent of companies with the lowest EB-ESG scores into a brown portfolio and the remaining 40 percent into a neutral portfolio. All portfolios have the same sector allocation in order to prevent the performance of individual sectors from distorting the results.

The analysis (see Figure 1 left) for the period from 2014 to 2024 shows a clear correlation between the sustainability of the portfolio and the fluctuation in returns (volatility). The portfolio with the most sustainable companies shows the lowest fluctuations. In addition, the maximum loss in value that an investor could suffer within the specified period was calculated for each portfolio.

Figure 1 on the right shows that an investor with the portfolio of brown companies recorded the strongest setback. The portfolio with the green companies also performs best in this respect. This shows that Investors with sustainable portfolios are exposed to lower risks[2].

ESG with AI: The recipe for success for good risk management

Another piece of good news: according to the analysis, the lower risks do not come at the expense of returns in the long term. The ten-year comparison (see Figure 2) shows: The portfolio with the most sustainable companies performs slightly better than the portfolio with the neutral companies. The brown portfolio once again brings up the rear.

Conclusion: The focus on sustainability is essential for managing portfolio risk. The AI-supported EB-ESG score helps to keep risk in check for investors without them having to sacrifice returns.

Legal information: This publication is an advertisement. All information is for general information purposes only and does not constitute investment advice or any other recommendation. All information and opinions presented are based on publicly available data at the time of writing and may differ in the future. Past performance and forecasts are not a reliable indicator of future performance. Further information on the opportunities and risks of the funds we manage can be found on the website www.eb-sim.de. The sales prospectus and further information are available at https://fondsfinder.universal-investment.com .

[1] The Wall Street Journal (2019) “PG&E: The First Climate-Change Bankruptcy, Probably Not the Last”

[2] The observations that sustainable portfolios have lower risks are not limited to equity portfolios alone. To illustrate this, we repeated the analysis and formed our portfolios from the bonds of the Bloomberg US Corporate Bond Index. To ensure that the observed differences are due to the different sustainability levels, the portfolios are similar in terms of country, maturity, rating and sector risk. As with equities, we also find a lower fluctuation (volatility) and downside risk (drawdowns) here.