InvestmentsMar 18 2021

Assessing a client's suitability for multi-asset investments

Supported by
BMO Global Asset Management
twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Supported by
BMO Global Asset Management
Assessing a client's suitability for multi-asset investments

As typically happens, the rise in client interest in environmental, social and governance (ESG) has been met by a range of new requirements on advisers from regulators. 

Central to those requirements is the new obligation upon advisers to include questions about a clients interest in, and suitability for, ESG investments.

Simon Holmes, portfolio manager, multi-asset solutions at BMO GAM says: "The demand for ESG-related solutions has increased significantly and that’s a trend we see continuing. 

"Several things provide impetus for that shift – regulation is key but there is also greater recognition that investing responsibly makes financial sense as ESG risks can have a material impact on returns. 

"Also, individuals are more aware of the challenges the world faces and are keen to do their bit through investment choices – avoiding investing in polluting companies for example. 

A lot of funds always looked at the governance part of ESG, but now they are also starting to pay attention to the risks that come from environmental and social impacts Alex Farlow, Square Mile Research

"At BMO, responsible investment sits at the centre of everything we do.  Consideration of ESG risks is integrated into our investment processes and we’re aware that sustainability related megatrends – such as a transition away from fossil fuels - provide some interesting investment opportunities.

"From a multi-asset perspective, it’s important to apply consistent parameters across all asset classes – whether we are investing in equities or fixed income, we operate within the same ‘avoid, invest, improve’ ethos."

But Alex Farlow, head of risk-based solutions at Square Mile Research, says that in reality choosing to ignore ESG, or place less emphasis on it than the market as a whole, is in itself a risk as public sentiment, and the wider regulatory climate changes. 

He says that when assessing the risk profile of a client, a client who is suitable for a higher risk portfolio, is also a client who can have a portfolio which pays less heed to ESG concerns.

Farlow says the key is for advisers to begin to think of ESG risk in the same way they think of liquidity risk or market risk.

Around £66bn of new capital went into ESG funds in 2020, and Farlow says that even many of the funds which do not have an explicit ESG mandate have recently begun to consider ESG risks as part of their investment process. 

He says: “A lot of funds always looked at the governance part of ESG, but now they are also starting to pay attention to the risks that come from environmental and social impacts, there has certainly been a lot of progress in that area.”

Keith Balmer, product specialist, multi-asset team, BMO GAM, agrees that advisers should view ESG considerations as another set of risks in portfolio construction, but added that this also applies to the types of assets invested in. 

He says one of the risks to consider is that most companies in the ESG universe are relatively young businesses that are growing quickly, and have enjoyed strong share price performance based on the expectation of future growth. 

Such stocks are often called growth shares, and the nebulous nature of many ESG-focused businesses, combined with inflows driving valuations upwards, means clients with a significant exposure to ESG themes risk simultaneously being extensively exposed to growth stocks, even when this might not be the appropriate place for a client to be. 

He says avoiding this concentration in any one part of the market probably requires using an active fund. 

Paris Jordan, analyst at Waverton, says: “With the introduction of ESG into the suitability questionnaire, every multi-asset specialist should be reviewing their product to ensure it will continue to meet client requirements.

"While the portfolio construction itself may not have to change immediately, the information disseminated to advisers will have to. Advisers will need to understand clearly if a portfolio meets their clients' ESG preferences.”

She adds: “Initially,  it is unlikely that all clients will want ESG portfolios and so the shape of existing multi-asset portfolios should not immediately need to change.

"But this will not always be the case as client demand for ESG is set to increase further – due to environmental awareness, demographics and the intergenerational wealth transfer.

"Longer term, multi-asset managers will have to consider this increase in demand and begin to shape their portfolio construction to cater for this. Managers will have to consider ESG criteria of individual investments and of the portfolio as a whole.

"If done well, this will take time and so, in the near future, it is important to recognise what is most pressing: delivering high quality and easily digestible ESG portfolio information so advisers can meet their regulatory requirements.”

Long-term obligations

Nick Watson, multi-asset investor at Janus Henderson says rules that are about to be introduced will mean all multi-asset portfolios will be obliged to consider ESG factors. 

He says: “Portfolio construction of the multi-asset strategies is going to evolve as new sustainability requirements come into force. With the EU Action Plan’s Sustainable Finance Disclosure Regulation (SFDR) being effective from March this year, investors will have a much better insight into a sustainability framework that a portfolio complies with, and choosing investments in line with their sustainability preferences should prove more straightforward.

"Constructing multi-asset portfolios in a sustainable manner in line with the stricter SFDR Article 9 for example, will mean portfolio managers would need to optimise risk-adjusted return outcomes in parallel to achieving sustainability objectives such as carbon exposure reduction, lowering carbon transition risk or supporting better diversity and inclusion practices.

"This will have implications on both asset allocation decisions (for example, building climate-aware capital market assumptions) and security selection criteria (for example, investing in assets whereby an intentional and measurable net positive impact is being generated).”

Iain Barnes, head of portfolio management at Netwealth says: “The regulatory emphasis on better understanding client views on ethical suitability is an exciting prospect. As ever, the devil will be in the detail of the UK regulation when it arrives and how it is interpreted. 

"As part of applying ESG screening, we are considering an approach that will amplify allocations in issuers or assets with high ESG ratings relative to their peers and reduce exposure to those that score poorly. There has been an explosion in investable funds offering different flavours of sustainability in recent years, so this task is becoming easier to fulfil on one hand but more demanding in terms of ensuring that due diligence is at the necessary level to get the right components into portfolios.” 

Bertie Dannatt, investment director at Ruffer, says all of the investments made by the company are selected using both an assessment of financial risk, and of ESG risk, and he believes it is “proper” that the regulator is ensuring greater clarity in the conversations around the topic. 

Ursula Marchioni, Head of BlackRock Portfolio Analysis and Solutions, EMEA at BlackRock says: “To date, many investors have focused on the implementation of sustainable practices at the product level.

"However, the focus is starting to shift whereby sustainability is incorporated at all stages of the portfolio construction process- from specified sustainable portfolio objectives, designing a strategic asset allocation (SAA) to help achieve these targets, and, finally, implementing this with products.”

Minesh Patel, an adviser at EA Financial in London says he uses a fact find questionnaire from Fund Eco Market, as the basis for the conversation he has with clients as a way to establish client preference and criteria. He then divides those clients who wish to have ESG into five buckets: Ethical, SRI,  Thematic, Impact, Sustainable, and ESG. He says most clients have some interest in ESG but few have a “definitive” view on what they want their exposure to be. 

David Thorpe is special projects editor of FTAdviser