Sustainability with different risk profiles

Whether you are a risk-taker or a conservative investor, you are spoilt for choice with thematic funds. This is because even related sustainability themes can have opposing risk characteristics. The examples of climate and water illustrate this.

Author: René Nicolodi, Head of Equities & Themes

Investing sustainably with themic funds is not just for risk-taking investors. (Image:

Melting glaciers are the most obvious sign of climate change in Switzerland. As they disappear, the freshwater reservoirs dry up and the entire water cycle begins to falter. Melt water will be sorely missed, especially in dry summers. In Asia, it is the retreat of the glaciers in the Hindu Kush and the Himalayas that is irreversibly changing the meltwater runoff and threatening around a quarter of the world's population with waterscarcity. The social and economic consequences are enormous.

But it is not just the lack of ice that will cause problems for humanity: With climate­warming and higher temperatures, more and more water is evaporating. Instead of wetting the soil, the precious water escapes into the atmosphere, which exacerbates drought in drought-prone areas. In Europe alone, annual losses due to drought amount to EUR 9 billion, particularly in agriculture, the energy sector and public water supply. This makes it all the more important to take measures to curb global warming and counteract water scarcity. The increasing urgency of these challenges offers great opportunities for companies with effective solutions.

While the two topics are closely linked, they have a fundamentally different risk profile and different characteristics from an investment perspective. This is evident, for example, in the different sector­allocations and in comparison to a broad global index (see chart).

The different sector allocation of the Climate and Water theme funds compared to a global equity index. (Source: Zürcher Kantonalbank)

Substitution, innovation and barriers to entry

A key difference between the investment topics of water and climate with regard to the risk-return profile is the substitutability: water is fundamentally not inter­changeable, neither as drinking water nor in the agricultural economy or in other areas. The situation is different with CO2-intensive fossil fuels such as gas, oil or coal: Electricity, for example, can also be generated without gas or coal if renewable energies are used instead.

Furthermore, unlike companies in the climate protection sector, water technology companies are hardly threatened by disruptive innovations. This is because the tech­nologies for water purification and distribution have essentially been known for decades and work convincingly. In addition, numerous water technology­providers have been able to build up a strong customer­relationship over the years, as many customers (e.g. water suppliers) require advice on the technology, water­treatment or distribution process. This customer­relationship represents a high barrier to entry for new competitors.

Climate protection technologies, on the other hand, often differ only slightly: solar modules, for example, "only" need to be efficient and cost-effective, regardless of where they are installed. Many innovative technologies are also characterised by enormous growth in demand, but also by very high price pressure. The most recent example is batteries for electric vehicles. Due to their interchangeability, climate protection companies are only insufficiently successful in establishing market entry barriers.

Another difference between the topics can be seen in the expected growth rates up to 2030: the water market is forecast to grow by around 4%, while the decarbon­isation market is expected to grow by a good 9% according to the International Energy Agency (IEA) - provided that governments consistently pursue their announced climate protection targets.

One concern, two risk profiles

The different characteristics of the two themes mean that investors with a completely different risk profile can invest in sustainability. Almost 20 years ago, Zürcher Kantonalbank launched two equity funds focussing on water and climate: The water fund pursues the sustainability goal of water conservation and sustainable water supply. The thematic fund invests in an established industry that has the rare charac­ter­istic of hardly being threatened by disruptive changes. The companies are growing slightly faster than the global economy and have high barriers to entry due to established customer relationships.

The Climate Fund invests in climate protection companies whose products and services are intended to decarbonise the global economy in just a few decades. Many of these technologies are disruptive in nature and offer enormous growth potential. The disadvantage is that some industries in the climate sector have low barriers to entry. However, this increased risk is largely compensated for by the additional growth potential.

Whatever the risk appetite of investors: With the two climate and water funds, they have two exciting alternatives.