Demystifying SFDR. What is it and how can it help your ESG investment strategy?

To make it easier for investors to identify and compare sustainable products, tackle greenwashing and ultimately direct capital towards sustainable investments, the European Union enacted the Sustainable Finance Disclosure Regulation (SFDR). 

SFDR came into effect in March 2021 and applies to mutual funds and ETFs, alternative investment funds, managed portfolios and financial advice. The regulation aims to provide more transparency and more information to investors, allowing them to better assess the veracity of fund managers’ sustainability claims. 

In short, SFDR should help investors make better-informed decisions.

SFDR requires EU-based asset managers, as well as non-EU-based asset managers that market funds in the EU, to classify their funds under one of three categories: Article 9 (dark green), Article 8 (light green) or Article 6 (no green). 

ESG risk and other important considerations

Despite its growing popularity, sustainable investing (aka ESG investing) still faces challenges, in particular when it comes to disclosure. Because many countries do not require companies to disclose ESG data, many funds might not have the needed company information to report. Thus, what risks happening, at least at the beginning, is that funds’ disclosure will be made on a best-effort basis and thus may be patchy and varied.

In addition, as the classification of funds is done by the asset managers themselves, there is a risk that some managers misclassify funds and mislead investors, especially at the start of the implementation of the new rules.  

When it comes to ESG performance, according to some studies (SRI & Performance study by LFDE, Foundations of ESG Investing by Giese, Lee, Melas, Nagy and Nishikawa), ESG strategies have tended to outperform non-ESG strategies in recent years. It is, however, important to note that, as ESG is a relatively new concept with little historical performance data, making inferences about ESG outperformance or the source of that performance is not recommended. 

The growing demand and interest for ESG investing has led to staggering inflows into ESG strategies which, in turn, have contributed to inflated returns for a number of ESG-friendly stocks. There is, therefore, a possibility that if demand for ESG investing goes down, performance might be negatively affected.

How to find ESG investing ideas

You can browse the Article 9 and Article 8 themes that provide lists of dark green and light green funds according to EU SFDR.

Before making any investments, remember to review the product’s information available on the platform and make sure to consider your investment objectives and risk tolerance, as well as your time horizon.