Understanding risk and reward in an ESG portfolio

This article is part of
Guide to Responsible Investing

Understanding risk and reward in an ESG portfolio

Advisers will face the increasing challenge in the years to come of trying to align a client's desire to have exposure to responsible investments with the client's risk profile. 

The challenge is that while a proliferation of new responsible investment funds have come to market, the evolution is not at the point where an adviser can know the attitude to risk of a fund manager, in the way they can, for example, by looking at the allocation to the highest risk bonds in a bond fund. 

Shaunak Mazumder, global equity fund manager at Legal & General Investment Management, says advisers can use standard measures of risk, such as examining the portion of small caps relative to large caps in a fund, and the level of diversification of a fund, as a way to understand the risk level. 

He says: “Just as with a regular portfolio, the less risk you take, the lower the returns will be. And if you buy companies which trade at high multiples, then the likelihood is that returns in future will be lower than if you buy a lower rated company.”

This view is echoed by Yuko Takano, global equity fund manager at Newton Investment Management, who works on a portfolio of four funds with different risk profiles.

She says the risk level of each fund can be viewed in a similar way to that of a non-ESG fund, with the analysis of the riskiness of a stock carried out in the same way as in a non-ESG portfolio, and with all of the stocks in all of the portfolios compliant with ESG principles. 

Angus Parker, who runs the HSBC Global Equity Climate Change fund, says the key to risk management within such a portfolio is to ensure that the client is not overly exposed to any one theme, government policy, region, or individual equity. 

For Sarah Norris, investment director at Aberdeen Standard Investments, the market has moved beyond the point where those investing in sustainable investment funds are required to sacrifice some returns, and, instead, sustainable investors are those more likely to offer protection against future risks.

She says a key part of an ESG investor’s role is to identify future economic and political trends, and understand how these will impact portfolios in future.

Norris says companies that have a strategy for investing sustainably are likely to be more in tune with changing consumer habits and regulatory issues.

Chris Iggo, chief investment officer, core investments at Axa Investment Managers, says the regulatory duty of an asset manager is still to think about risk in the financial sense, and says his approach is generally to create portfolios based on an initial investment scenario, such as having bonds with a short date to maturity, and then add the ESG analysis on top of that. 

In that precise scenario, he says the outcome would be that the bonds which get into the portfolio would have an even shorter date to maturity as a result of ESG concerns.