Building a truly diversified sustainable equity portfolio

This article is part of
Guide to building a sustainable global equity portfolio

Building a truly diversified sustainable equity portfolio

Whenever an investment theme becomes fashionable, a torrent of cash flows into the sector, with the result that valuations go higher and more cash goes in.

This can lead to investors being over exposed to certain sectors of the economy and the risk of bubbles emerging in those sectors. 

Louis Florentin-Lee, sustainable equity fund manager at Lazard, says: “A top-down approach is likely to lead to a portfolio that is skewed to certain sectors, geographies or types of companies.

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“The risk of a top-down approach is that these types of portfolios become too concentrated, offering clients a less attractive risk-reward balance.

“Furthermore, by focusing on a smaller number of sectors as part of a top-down approach, there is the added risk of overlooking some attractive investment opportunities in companies operating in sectors not obviously associated with sustainability.”

He says as sustainability is likely to have a wide-ranging impact, managers doing thorough research should be able to find great opportunities to invest across different sectors globally.

‘Hype cycles’

Craig Bonthron, global sustainable equity fund manager at Kames, says: “It is one of the challenges in terms of building a sustainable portfolio right now.

“Quite often a theme becomes very popular, and everyone piles into it. But, thinking in terms of themes is probably too simplistic.

“I think an example of that right now is probably robotics. There are some good robotics companies out there, but what is happening is funds are being launched to only invest in robotics, when in truth there are probably four good robotics companies, not 30, and it is 30 you would need to create a fund.”

Key points

  • Thinking in terms of themes can be problematic
  • When everyone falls out of love with a sector, that is the time to invest
  • A sustainable portfolio will tilt towards quality stocks

He says that whenever an innovative investment theme comes to market there is a “hype cycle”, whereby everyone piles in and the price of the asset loses touch with the underlying fundamentals.

Mr Bonthron adds: “Then what happens is, the bubble bursts, and there is a slough of despond, where everyone thinks the innovation is useless. In truth, that is the time to invest.”

He says renewable energy is an area that “had its hype phase just before the global financial crisis, and then its slough of despond, so I don’t think it is in a bubble now.

“But the problem is that it is hard to know what to invest in – energy is a commodity, so ultimately, they are selling commoditised products and it is not easy to tell which of them is the best company.”

Renewables bubble

Katherine Davidson, sustainable equity fund manager at Schroders, says she thinks renewable energy may be in a bubble now. 

For example, she thinks renewable energy supply chain stocks are in bubble territory.

Ms Davidson says the key to achieving diversification in a portfolio is geographical diversification.

She says the MSCI indices of sustainable equities tends to be very focused on companies in Europe, and reliant on a small number of sectors or themes.