The challenges of constructing a sustainable multi-asset portfolio

This article is part of
Guide to sustainable multi-asset investing

"Within ESG portfolios long-dated government bonds may need to be replaced with high-grade corporate paper and cash, which could in turn limit your ability to allocate to higher yielding bond assets as this combination may not provide as much downside protection as a traditional government-bond-heavy allocation.”

Holmes says the allocation to equity in portfolios is the main determinant of risk level, something that he feels does not change when sustainable investment criteria are added to a portfolio’s mandate. 

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Craig Mackenzie, manager of the Aberdeen Standard Multi-Asset Climate Solutions fund, says: “The reality is that with an ESG portfolio, or any other portfolio, you get the risk associated with the asset class; the challenge in the sustainable investment market is if you buy a very concentrated portfolio, like a renewable energy exchange-traded fund, you end up with something that is very volatile – that product went up 60 per cent last year, but is down a lot this year.

"It has proved to be much more volatile than equities are, about one and half times more volatile than equities, and shows the risk of being overly concentrated.” 

One of the major challenges of constructing an equity portfolio with sustainable investment criteria in mind is that many of the businesses that are sustainable fit into the 'growth equity' camp, rather than the 'value equity' one, and so leave investors exposed to only one type of market. 

Rathbones' McIntosh Whyte says: “I think if you have the whole of global equities to work with you can find a balance of growth and value stocks, but you definitely have to work harder to do it. You can’t really find any sustainable stocks within areas such as financials, which are a major part of the value universe, but industrial companies are interesting and many of those are sustainable – the universe is certainly improving.”  

Holmes says that: “Realistically you are going to have to have a tilt to growth stocks, but one way to have value is to look at the minerals which go into renewable products, as those would perform in a more cyclical way, like value stocks.” 

James Sullivan, head of partnerships at Tyndall, says that if one “unbundles” the different components of ESG investing, it becomes easier to diversify. By viewing companies as complying with one or two of those criteria, if not yet the third, the options for portfolio diversification become broader. 

Chris Hiorns, head of multi-asset strategies at EdenTree Investment Management, says while there is a risk when building a sustainable equity allocation that one ends up concentrated in areas such as clean energy and technology, one alternative is to buy infrastructure assets, which tend to be sustainable.   

Tatton's Saunders says the picture will evolve over time, with many areas of the market that are presently considered both growth and ESG compliant right now likely to be regarded as value stocks at periods of time in future.