In a groundbreaking study conducted by Danske Bank, researchers have delved into the intriguing question of whether an equity index that excludes companies based on sustainability factors can outperform or underperform an index that includes all companies. The findings shed light on the impact of sustainable investing strategies on financial performance, challenging conventional wisdom and offering valuable insights for investors.
The study focused on comparing two global indexes over the period from 2019 to 2024: one that excludes companies based on sustainability criteria and one that includes all companies. The exclusion portfolio had lower exposure to energy, industrial, and utility companies, while the standard global index had higher exposure to IT, healthcare, finance, and communication sectors. This comparison revealed interesting trends in performance and sector allocation, providing a glimpse into the potential benefits of sustainable investing.
“We have examined the most common exclusion criteria among Nordic investors by analyzing their investment policies, which has allowed us to draw conclusions about the criteria typically applied,” explained sustainability analyst Alexander Lindwall.
One of the key findings of the study was the significant outperformance of the exclusion-adjusted index compared to the standard index, with a margin of over 4%. This outperformance was primarily driven by the exclusion-adjusted index’s overweight in sectors like IT, which performed well during the period, while underweighting sectors like energy, which faced challenges.
Furthermore, Danske Bank’s research revealed that the differences between the two indexes were amplified during periods of specific events, such as the COVID-19 pandemic. The surge in remote work and the strength of the IT sector contrasted with the weakness in the energy sector, highlighting the impact of sector allocation on performance.
Another key insight from the study was the higher exposure of the exclusion-adjusted index to companies with quality, growth, and momentum attributes, which were key drivers of performance during the study period. This higher exposure to favorable themes contributed to the outperformance of the exclusion-adjusted index.
While the exclusion-adjusted index exhibited higher volatility, indicating higher risk, the study emphasized the importance of understanding the impact of selection criteria on returns and risk. The fluctuating performance of the two indexes underscored the need for investors to be aware of how exclusions can affect investment outcomes.
In conclusion, the study provided valuable insights into how common Nordic sustainability-related exclusions can impact the performance of a global equity portfolio. By analyzing the effects of excluding companies in sectors like oil sands, coal, tobacco, controversial weapons, and poor corporate governance, investors can make more informed decisions about sustainable investing strategies. With sustainability considerations playing an increasingly important role in investment decisions, understanding the nuances of exclusion criteria is crucial for achieving both financial and environmental goals.