Sustainable investing has now become a key element that the majority of investment management firms are integrating into their investment processes.
As such, investment managers like Quilter Cheviot’s Vanessa Eve, do not believe it will fundamentally change the multi-asset investing approach.
Investors will still need strong diversification from different types of assets to smooth investment returns over time, Eve says, but what will change is the sort of investments seen within portfolios.
She adds: “More emphasis will be placed on those firms who are adopting the UN-backed principles for responsible investment, as well as companies that align their strategies to the UN’s sustainable development goals.
“These principles are being extended beyond company shares and can now be found within fixed interest assets.
“As such, you can still adopt a multi-asst approach with a focus on sustainable investing. And with the next generation of investors more inclined to support investments that have a sustainable focus, this facet of investing will become a normal part of the research undertaken when adopting a multi-asset approach.”
Challenges of sustainable investing
Multi-asset funds that follow a sustainable investment process are naturally more complicated than single-asset strategies.
Even attempting to agree a fixed definition of sustainability is so difficult at the moment, that Rahab Paracha, sustainable multi-asset investment specialist at Rathbones, says there is no point trying to create a model to consistently apply metrics to formulate long-term capital return assumptions.
A rigorous environmental, social and governance risk framework should help, however some sectors will clearly be more impacted than others, such as property, transport, agriculture, healthcare and manufacturing.
Paracha adds: “In assessing any company you need to understand the risks of increased government intervention through either regulation or financial incentives – positive and negative.
“Those more vulnerable to external factors such as these will have a higher ESG risk score and therefore you would require a higher return on capital to justify an investment. This needs to be assessed at the micro level, which means you need to do the work. No short-cuts.”
With more asset classes to consider, each of which with its own characteristics and complications, Paracha says it is important that the fund’s objectives and investment process are clear.
As sustainability is a complex area, it requires an expert approach to deep dive into each company’s sustainability credentials, looking at areas such as supply chains and climate reporting.
“Equally, sustainability analysis for multi-asset investing shouldn’t stop at the equities or even the corporate bonds,” Paracha adds.
“The process for more complex asset classes such as government bonds and commodities should also be carefully considered and implemented to ensure all asset classes are aligned with the sustainable objective.
“This can mean that having sufficient diversification and tools to manage risk can at times be a challenge, as some investments are excluded, but we believe that we have enough levers to pull to ensure proper diversification for our sustainable multi-asset portfolios – although sometimes it does require thinking a little outside the box.
“For example, instead of investing in oil and gas companies to hedge against an oil price spike, we might invest in bonds with commodity-linked currencies such as bonds denominated in the Norwegian krone or Australian dollar.”
Sustainability analysis for multi-asset investing shouldn’t stop at the equities or even the corporate bonds.Rahab Paracha, RathbonesAnother way to integrate sustainability into capital market assumptions is through using quantitative climate scenario analysis, according to David Attwood, senior investment analyst in the strategic asset allocation research team at Abrdn.
Climate change poses long-term risks to investment returns, both as a result of damage to physical infrastructure form a changing climate and as a result of the economic shifts as the world transitions to a zero-carbon economy.
So if climate change affects risk and return, then it should be included when developing views on expected returns for asset allocation purposes.
Attwood says: "Our climate framework provides an assessment of an asset’s fair value under a range of climate scenarios (ranging from net-zero outcomes to 'hot house' worlds), from which we can understand the 'mis-pricing' when compared to current market prices.
“Through making assumptions about how quickly this mis-pricing will be corrected, prospective return forecasts for core asset classes can be adjusted.
“Improved workforce participation and corporate governance – components of the S and G pillars of ESG – can also improve corporate profitability, which is a key driver of listed equity total returns."
Traditionally lower risk investments are now producing attractive returns and as such should be considered as part of a fully diversified multi-asset portfolio.Vanessa Eve, Quilter CheviotHe adds: “The implications of sustainability factors on risk characteristics is a growing area of research, and only through improved reporting and disclosure – not to mentioned growing historical data – will we understand more [about] the inter-relationships.
"At present, we therefore prefer to express our views through return adjustments rather than risk, accepting of course that the combination therein is one of the fundamental drivers of asset allocation outcomes."
What investors prioritise will fundamentally depend on their own unique financial objectives.
But Quilter Cheviot’s Eve says investors should be looking more closely at fixed interest investments given the massive valuation changes seen over the past 18 months.
She says: “Fixed interest investments are now providing positive returns with 10-year gilt yields moving from 0.975 at the start of 2022 to 4.18 per cent by the end of May 2023.
“As such, traditionally lower risk investments are now producing attractive returns and as such should be considered as part of a fully diversified multi-asset portfolio of investments.”
The shift in mindset of what a more sustainable world will mean is still to be fully played out, as we are very much in the foothills of the climb.
Kelly Prior, investment manager in the multi-manager team at Columbia Threadneedle Investments, says: “I believe all asset classes are adjusting.
"To lend money to an unsustainable company carries over an increase in risk as these players are increasingly shunned, consequently meaning both refinancing and business models will become more troublesome in general.
“We are at a pivotal point in investments where an increasing number of firms are being considered as sustainable, having shed the negative externalities that they once produced. In an equity world, this will impact future earnings potential.
"Nonetheless, the shift to a more sustainable focus will not guarantee a wholesale shift in structure.
“Instead a more inclusive approach will be more beneficial for the long term when looking at all asset classes.”
Ima Jackson-Obot is deputy features editor at FTAdviser
