Breaking Down the Transparency Wall of Sustainability: A Study of the Environmental Sustainability in Danish Investment Funds

Abstract

With a growing focus on ESG and sustainable investing, a report from August 2021 revealed that more than 70% of ESG funds fail to align with the global climate targets set in the Paris agreement from 2015. To further research this concerning matter, this paper conducts a comprehensive analysis of Danish sustainable investment funds and their environmental level of sustainability. By utilizing ESG ratings as well as sectorial weights, we develop a novel scoring method attempting to address the environmental impact of companies relative to global climate targets. Using this innovative approach to portfolio analysis, we evaluate the funds based on their underlying holdings and the allocation of capital. This study furthermore examines the potential of improving the environmental impact and attach importance to abandoning the current view on sustainability in the investment funds. The results indicate a suboptimal capital allocation of the Danish investment funds in relation to global climate targets. Sectors with limited capacity to drive environmental change constitute the majority of capital, namely investments into Technology, Healthcare and Financials. Meanwhile, sectors with the largest capacity for environmental impact have an insignificant allocation, which highlights the need for a greater focus on these sectors in the portfolio selection process. This sectorial focus does however come at the expense of expected Sharpe Ratio but given the current suboptimal risk-diversification of the Danish funds, the results of this study indicate that major improvements regarding environmental impact could be achieved without compromising financial performance. The results further show that despite slightly improved ESG ratings in sustainable funds compared to traditional market indices, little to no enhancement in environmental impact is observed. This indicates a lack of transparency in both sustainable investments and ESG ratings, which calls for more standardization as well as regulation.