Dow Jones' strange definition of sustainability

When you think of sustainable publicly traded companies which ones come to your mind? Tesla? Enel? Maybe Unilever? There is a wide consensus that all of these companies are making an effort towards a more sustainable future and therefore it would be reasonable to assume that they fit a company‘s definition of a sustainable investment. But how about Volkswagen, British Tobacco, Pirelli or Tata Steel? The world largest index provider Dow Jones includes all of them in its "Dow Jones Sustainability World Index" even considering them to be Industry Leaders - so let me explain!

Asking an expert

A couple of weeks back at GL4B's Redesigning Sustainability event we invited Giuseppe Zammarchi, Unicredit's Head of Group Sustainability over to our university to get an insight into the sustainability efforts that big financial institutions are making.

He stressed the importance of environmental sustainability for securing the future of a business, illustrated UniCredit's own sustainability efforts that already got rewarded various times and highlighted the fact that sustainable investments will in the long term yield similar returns while being less risky due to their forward-looking approach. After the talk, I took the chance to ask him about exactly this statement, mentioning that major sustainability indices were rather underperforming their benchmarks recently while at the time showing similar levels of volatility. He told me not to blindly trust every index with the with the words sustainability or green written in its name as long as I do not fully understand the way it is made up of and evaluate whether their selection criteria match my own values and judgements considering sustainability - Quite a lot to think about but let me break it down for you!

The first Sustainability Index

So I did some research and I slowly started to see his point. Let’s look at the most common sustainability index, the DJSI World (short for Dow Jones Sustainability Index). What comes to your mind when reading this tweet?
Well, it seems logical, right? Bayer was just in the process of acquiring Monsanto which is widely seen as a unsustainable company so it makes sense to exclude Bayer after the acquisition. What you should really ask yourself, however, is how Companies like Bayer or British Tobacco made it into that index in the first place! Surely, selling Aspirin does not cause much harm to society but it is not what I consider characterizing a sustainable company and how about selling cigarettes? It reveals how the index is formed: In order secure a place in the DJSI, first set up in 1998 by the Swiss investment company RobecoSAM, a firm does not have to be sustainable per se but merely compared to its peer group. Putting it simple, as long as Bayer is more sustainable than most of its competitors it will get its place in the index.

This procedure should raise another question: Which sectors is the Index even concerned with? The answer might be surprising. “Electrical Utilities” for example is one of the 60 sectors, as is “Oil Refining”, ”Oil Upstream”, “Oil Storage”. The rationale behind this is mainly diversification, forming an index solely out of solar companies is meaningless since the index will be almost as volatile as its single components. The other reason is that especially in very polluting sectors much can be done to reduce the negative environmental impact. Keeping ideology aside, this is a very valid argument. Nevertheless, we can say for sure that this is most likely not what the average environmentally conscious retail investor is looking for - especially since RobecoSAM's definition of sustainability is also rather controversial. It almost equally weights environmental, economic and social sustainability (with industry-specific differences) which explains how a highly polluting company can enter the index as long as it pays a fair wage to its employees. After these three factors are ranked and weighted you are left with a "sustainability" score and if you're lucky enough to be among the top 10% of your industry you'll get included into the most renown DJSI World while being among the top 30% in your country can still save you a spot in a country specific index like the DJSI Chile.

Some alternatives are even worse

So what about an index solely made up of the, say, ten most (environmentally) sustainable companies of one country or region? This is precisely what the ÖkoDax did when it started operation in 2007. The index still exists, however investing in it seems almost ludicrous. 7 of the 23 components that were at some point included in the index went bankrupt in the past decade and among the ones surviving are companies like Nordex, the most heavily shorted company on the German stock market. Investing 1000€ in the ÖkoDax ten years ago (Nov. 2008), would leave you with only 100€ (-90%), compared to 2600€ in the German Dax (+160%) and 2300€ in the MSCI World (+130%).
So, what went wrong? The reason for the ÖkoDax’ failure can be found in the principals of the DJSI, diversification and economic stability. Not only were all ÖkoDax companies part of the same economy (Germany) but also picked from the same sector: Renewable Energy (Solar, Wind, Bioenergy). What seems logical at first turned out to be the index’ major flaw. Competition for the same market will naturally drive some companies out of business and a simple cut in domestic subsidies for renewable energy could mean an loss of several percent a day and force some companies to shut down.

The silver lining

So what about a diversified index (both geographically and industry-wise) that only contains truly sustainable companies. Luckily, there are alternatives! In contrast to the disastrous example of the ÖkoDax, I want to present you another German stock index with a different selection approach. The NAI (Naturaktienindex) selects stocks from all around the globe (16 countries from 6 continents) that fulfill certain sustainability criteria while also showing a solid operating business. In the Index you’ll find stocks from very different sectors ranging from transportation (Tesla, East Japan Railway, Shimano) over food and nutrition (UNF, SunOpta) to recycling (Tomra, Stericycle, Sims). It therefore combines a selection of truly sustainable stocks while at the same time yielding a plus of 190% over the past ten years therefore vastly outperforming both the DJSI and MSCI World.


I think there is a lesson to learn from this analysis: Diversified truly sustainable investments are good investments. Common believe often dumps sustainability efforts as a kind of "donation to the environment", meaning giving up profits for an increase in social welfare. The stock selection of the NAI proves this to be wrong. The companies selected are not performing well although but because they are sustainable. For an investor that means above average returns and lower long-term risk - Giuseppe Zammarchi would be proud!

Read more