Moving the needle? Six insights into SDG investing

The Framework, launched in 2017, is a robust tool that systematically assesses individual companies on their contributions to key targets for the 17 SDGs. These contributions are aggregated into an SDG score, which can be used to construct portfolios that pursue positive impact, avoid negative impact, and support sustainable progress in the economy, society and the natural environment.

Over the years, we have built a strong track record of integrating SDG scores in our investment portfolios, with our dedicated SDG solutions on average nearly doubling in assets under management between 2018 and 2023. For Robeco, SDG investing is no longer a niche practice; ultimately, our goal is to make it the new norm for sustainable investing.

However, investors still ask questions about issues ranging from whether SDG scores do better than ESG analysis or mean lower returns, to whether they have their own biases, or do anything to further the pursuit of net-zero goals. Here we offer six key takeaways from the research conducted for the revised SDG Framework published in September 2024.

It’s important to know whether the SDG Framework works better in capturing companies’ impact on sustainable development than traditional environmental, social and governance (ESG) metrics which can look at similar variables. So, we tested them.¹

We found that companies that are on asset owners’ exclusion lists, those that breach the EU Taxonomy’s do-no-significant-harm (DNSH) principle, and companies that are among the 100 highest carbon emitters predominantly get negative SDG scores. Conversely, the majority of companies that have significant Taxonomy-aligned revenues or provide solutions in the field of health and well-being, water and sanitation, or sustainable energy, are assigned positive SDG scores.

Meanwhile, none of the ESG ratings studied were found to align with the sustainability preferences of investors, regulators and scientists. ESG ratings are simply not suited to differentiate between companies with positive and negative impacts. This confirms the validity of our SDG scores in capturing real-world impact.

An often-heard concern is that sustainable investing leads to lower returns and less diversification in portfolios. We investigated this notion by running a historical simulation between two portfolios: one that avoids stocks with negative SDG scores and one that is unconstrained.

The findings show that the positive SDG investment approach did not lead to lower returns compared to the market index. In addition, the two portfolios showed highly similar risk levels and the diversification benefits were virtually identical. This suggests that investors can utilize an SDG lens without compromising their financial objectives.

Scandals can lead to loss of stakeholder confidence and may have long-term reputational or financial consequences for companies. A research collaboration between Robeco and the University of Zurich led to a recent article titled ‘Corporate Sustainability and Scandals’, which examined the link between our SDG scores and involvement in future controversies.²

It found that companies with higher SDG scores have a lower probability of being involved in scandals, and if they do become embroiled in one, these are less severe and cover fewer contentious topics. This suggests that our SDG score is a useful tool for sustainability-minded investors who want to avoid negative financial implications stemming from corporate scandals.

A criticism of ESG ratings is that companies that are larger in size, are from developed countries, or have more resources for providing sustainability disclosures are assigned better ratings. Our SDG scores were academically tested on whether they exhibit similar biases in a recent paper entitled ‘Sustainability Matters: Company SDG Scores Need Not Have Size, Location, and ESG Disclosure Biases’.³

The findings suggest that this is not the case, meaning SDG-aligned investment portfolios avoid undesirable biases stemming from the way our SDG scores are constructed. This is an important finding considering that investors have more potential to create positive impact by investing in companies that face capital constraints, a situation more common among smaller companies and those operating in emerging markets.

Robeco has long practiced 3D investing, combining the assessment of risk, return, and sustainability as the third dimension. The value added by sustainability was examined in a paper entitled ‘3D Investing: Jointly optimizing return, risk and sustainability’, which used the Robeco SDG scores as the third dimension rather than traditional ESG metrics.⁴

It found that 3D investing yields higher sustainability metrics and expected returns compared to a 2D model with constraints, such as the use of basic exclusions. A combined strategy, blending a flexible sustainability constraint with integrating sustainability into the optimization process, offers a balance between return, risk and sustainability goals.

Finally, a massive challenge – and opportunity – in sustainable investing today lies in the transition to achieve net-zero emissions by 2050. Of the 100 companies with the highest greenhouse gas emissions in the MSCI World Index, 63 have a negative SDG score. Furthermore, the 27% of MSCI companies with a negative SDG score are responsible for 72% of all emissions.

Conversely, the 53% of companies with a positive SDG score account for only 21% of the index's emissions. Thus, by increasingly avoiding negative scoring companies, investors will indirectly reduce exposure to high emitting firms, and thereby align with decarbonization objectives. The figure below shows these results.

Footnotes

¹ESG to SDG: Do Sustainable Investing Ratings Align with the Sustainability Preferences of Investors, Regulators, and Scientists?
² Corporate Sustainability and Scandals
³ Sustainability Matters: Company SDG Scores Need Not Have Size, Location, and ESG Disclosure Biases
⁴ 3D Investing: Jointly optimizing return, risk and sustainability’