Understanding risk and reward in an ESG portfolio

This article is part of
Guide to Responsible Investing

More risk considerations

Jennifer Anderson, co-head of sustainable investing and ESG at Lazard Asset Management, says the duty of money managers in the future will be to broaden the number and types of risks considered when making an investment, adding the risk of negative outcomes from ESG impacts on society to the list.

She says: “Where in the past, ESG issues were addressed primarily through restrictions and guidelines, investors now increasingly see that these questions are more nuanced and need to be addressed more thoughtfully. By integrating a more comprehensive set of ESG considerations into our process, and by recognising the linkages between returns on financial capital and how companies manage their human and natural capital, we believe we are able to better deliver attractive risk-adjusted returns on behalf of our clients.

"We strive to build portfolios that are well diversified and that deliver the most attractive risk-adjusted returns for our clients. Of course, we recognise that the opportunity set for sustainable investing looks different across regions and investment styles and that the thresholds for inclusion in a sustainable portfolio can therefore vary accordingly.”

Iggo says there is a material risk that by, for example, investing in oil companies, one could end up owning “stranded assets”, that is, assets that are worth a negative amount on the balance sheet, and so drag down the returns available to shareholders, and this is a risk that might not be captured by examining traditional investment risk questions alone. He says this is particularly the case as investor priorities change over time, creating a new set of risks.  

Martijn Kleinbussink, portfolio manager on the Kempen sustainable equity team, says: “Investors should caution against getting overly excited about the sustainable opportunity and forgetting the financial return.

"This is why we focus primarily on quality in our analysis. We want to invest in the transition to a sustainable economy, not subsidise it. We look for high-quality industries that are undergoing a sustainable change.

“Secondly, we look for the companies within a high-quality industry that are well positioned for sustainable change. Finally, we undertake an extensive valuation exercise to assess the potential returns of investing in a sustainable opportunity. Only when all of these factors align, do we invest. In this way we ensure that we will not only take care of the sustainable returns, but also our client’s required financial returns.”

Paul Niven, head of multi-asset portfolio management at BMO Global Asset Management, says: "In a low interest rate world and one where the outlook for company earnings is uncertain, sourcing attractive and reliable sources of yield is a challenge.