Think differently

“Dark green” equity funds could go “full green” with very limited impact on their risk profile

Aurore Porteu de La Morandière , Scientific Portfolio ESG Researcher
Benoît Vaucher , Scientific Portfolio (an EDHEC Venture) Director of Research
Vincent Bouchet , Scientific Portfolio (an EDHEC Venture) ESG Director

Sustainable investment funds have blown up in size in the last decade. However, many funds that claim to be sustainable still contain stocks of companies involved in greenhouse gas-intensive industries. In this article, Scientific Portfolio (an EDHEC Venture) researchers present their newest study in which they analyse the impact of the exclusion of these controversial stocks on the performance and risk profile of these funds.

Reading time :
15 May 2024

Sustainable investment funds have blown up in size between 2012 and 2022, from 1 to 3 to 1 to 10, depending on the nature of the funds analyzed (1). Make no mistake, that doesn’t mean the financial sector has achieved its green transition: the shift is probably going to take a long time. However, the regulatory and political environment for responsible investment funds is getting more and more stringent, as a way to avoid greenwashing risks.


Since March 2021, the European Union’s SFDR (Sustainable finance disclosure regulation) (2) has been mandating investors and private banks in the EU to classify their funds based on their ESG criteria integration. But many funds that claim to be sustainable still contain stocks of companies involved in questionable industries, like coal or oil. So, what is the impact of these controversial stocks on the risk profile of these funds? Can the holding of these stocks in sustainable funds be justified? Overall, do climate-related exclusions have an effect on portfolio risk?


These are the questions researchers from Scientific Portfolio (an EDHEC Venture), Aurore Porteu de La Morandière, Benoît Vaucher and Vincent Bouchet explored in their latest study called "Do climate-related exclusions have an effect on portfolio risk and diversification? A contribution to the ‘Article 9’ funds controversy" (3).


Are SFDR article 9 funds really green?

The European Union’s SFDR defines three levels of ESG integration in funds corresponding to its Article 6, Article 8, and Article 9 (4). Some are referring to Article 8 funds as light green and Article 9 as dark green, the latter requiring a stronger commitment to sustainability.

Thereby, funds that claim to have a “sustainable investment objective” must comply with Article 9 requirements. But the SFDR leaves room for interpretation of what sustainable investment means. It does not define the levers that have to be used to achieve the sustainable investment objective: exclusion policies, reallocation, or shareholder engagement.


In November 2022, two platforms called Follow the money and Investico published the Great Green Investment Investigation (GGII) in collaboration with a dozen European media (5). They revealed that nearly half of the 838 European ‘Article 9’ funds had invested in companies that are involved in the fossil fuel and aviation sectors. Following this investigation and other controversies, 40% of the initial Article 9 funds were downgraded to Article 8 by the fund managers at the end of 2022.


Among Article 9 funds maintained are equity funds who play an important role in these markets and it's worth taking a close interest at their composition. Despite the 2022 wave of reclassification, the Scientific Portfolio (an EDHEC venture) study (3) finds that out of 161 equity funds that have an “Article 9” sustainable investment objective, 50 still contain stocks of companies involved in coal, oil and gas or aviation. The holding of these controversial stocks in portfolios seen as sustainable can be explained by several reasons: data discrepancies in the assessment of their environmental impact, a strategy of gradual exclusion, a fear of financial underperformance, or a willingness to engage with the company as a shareholder with the objective of improving their practices.

Whatever the reason, the important question of the impact of the exclusion of these controversial stocks on the performance and risk profile of the funds arises.


Does excluding companies from portfolios really cost performance?

Climate change is the most common reason (6) why companies are ruled out by banks and investors. But does excluding “brown” stocks alter financial performance? Several studies have investigated the effect of the exclusion of fossil fuel stocks, with mixed results: Henriques and Sadorsky (2018) find negative effects, while Trinks et al. (2018) find no difference and Hunt and Weber (2019) find positive effects. (7)


This Scientific Portfolio study tries to focus on the effects of exclusion on risks rather than short-term performance. The key finding of this study is that removing controversial stocks has no significant impact on the risk profiles of “Article 9” sustainable funds and that these effects can be reduced by optimizing the reallocation.


To be more precise, the exclusion of these stocks, even with a naive reallocation*, has a limited effect on tracking error (on average, the tracking error between funds without exclusion and with exclusion is 0.53%). Optimizing the reallocation slightly reduces tracking error to an average of 0.40%. The results are consistent with those from Trinks et al. (2018) long-term analysis (7). Exclusion also has a small effect on the fund's sector deviations, while in some cases, it causes some deviations in exposure to the quality, investment and value risk factors (8). However, a risk minimization method can significantly reduce these deviations.


Is holding unethical stocks in sustainable funds justified?

The thing is: ESG funds tend to suffer weaker demand, as investors often fear underperformance. And, despite a global movement towards ethical investing, a large number of funds (even sustainable ones) are still exposed to controversial industries.


Yet, the results of the study suggest that holding stocks with a negative contribution to climate change in sustainable funds is not justified from a risk perspective. Therefore, it seems essential that asset managers justify the holding of these stocks: for example, by a shareholder engagement policy aimed at improving the practices of the controversial companies.

However, these results should not be generalized to all funds nor to all exclusion policies. They concern specific climate-related criteria, as well as funds claiming a sustainable investment objective.


In the future, an interesting avenue of research would be to extend the analysis of the effects of exclusion on risk metrics to other exclusion criteria, including social and governance issues, and on a broader selection of classic and sustainable funds.


* Where the stocks remaining after exclusions are reweighted in proportion to their initial weight


(1) a. Responsible Investment Funds Build Consistent Market Presence (Feb. 2024), CFA Institute -

b. 2012: 220 bn USD - 2022: 2497 bn USD. World Investment Report 2023, United Nations -

(2) Sustainability-related disclosure in the financial services sector -

(3) Do Climate-Related Exclusions Have an Effect on Portfolio Risk and Diversification? A Contribution to the Article 9 Funds Controversy. May 2024, Scientific Portfolio Publication. Aurore Porteu de La Morandière, Benoît Vaucher and Vincent Bouchet -

(4) Regulation (EU) 2019/2088 of 27 November 2019 on sustainability‐related disclosures in the financial services sector -

(5) The Great Green Investment Investigation. Follow the money, Investico -

(6) Climate change leading cause for excluding companies from portfolios: report (Oct. 2023). ESG Dive -

(7) Investor implications of divesting from fossil fuels. Irene Henriques, Perry Sadorsky - Global Finance Journal (2018).

Fossil Fuel Divestment and Portfolio Performance. Arjan Trinks, Bert Scholtens, Machiel Mulder, Lammertjan Dam- Ecological Economics (2018).

Fossil Fuel Divestment Strategies: Financial and Carbon-Related Consequences. Chelsie Hunt and Olaf Weber - Organization & Environment (2018).

(8) Factor Investing: A WelfareImproving New Investment Paradigm or Yet Another Marketing Fad? EDHEC-Risk Institute, July 2015 -

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