Funds seek out a better quality set of companies

This article is part of
Multi-Asset - November 2014

Multi-asset funds offer investors flexibility to spread risk by investing across a range of asset classes, such as equities, bonds and cash, but also other asset classes such as property or commodities.

Sustainable multi-asset funds are available and they put greater emphasis on incorporating environmental, social and corporate governance (ESG) issues into the investment decisions than their conventional peers.

This is done in a number of ways:

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• The traditional and often most common element is basic screening out of no-go areas, such as companies with a poor human rights record or certain sectors such as tobacco.

• Positive screening is when the fund manager actively looks for companies set to benefit from sustainability themes, such as a company producing a technology that enables its customers to reduce their environmental impacts, as well as their ongoing costs.

• Engagement (meeting with companies) is another tool used to challenge companies on the way they manage their interaction with society and the environment. Shareholders are able to use their voting rights to improve corporate management for the benefit of the business, as well as broader society.

The key to implementing a sustainable investment strategy is a well-resourced and knowledgeable team that understands how sustainability challenges will affect companies and reflect these views in the funds.

But ESG issues alone are not enough; assessing companies’ business fundamentals and valuation is still an important aspect for sustainable investment funds.

Multi-asset funds rely on delivering investment returns from two areas: stock selection – individual stocks performing better than the market – and asset allocation, which is the proportion invested in equities, bonds and cash.

By investing in more sustainable companies, sustainable funds believe they invest in a better quality set of companies. And there are sustainable funds that deliver similar investment returns to conventional, non-sustainable funds.

The decision on how much to invest in each asset class is made by taking consideration of economic conditions, both in the short and long term, and valuation of the relevant asset classes, both against each other and against their long-term average. Sustainable funds include this element, too.

Some asset classes, such as commodities and commercial property, are underserved by sustainable funds. However, the equity and corporate bond components in sustainable funds tend to get exposure to these asset classes, so some diversification benefits take place within these assets.

The overall diversification and volatility exposure, relative to mainstream peers, tends to be very much comparable.

It is possible to provide sustainable multi-asset funds that are significantly different from conventional funds, but that broadly reflect clients’ values, at the same time as delivering similar investment returns.

Sustainable funds are often more transparent, allowing investors to see all the companies invested, as well as which sustainable investment themes they are exposed to and how they are engaging with companies to encourage positive change.

Simon Clements is an investment manager and Harriet Parker is an investment analyst, sustainable and responsible investment, at Alliance Trust Investments