Bringing ESG into multi-asset investing

From time to time, episodes occur when asset prices move some distance away from their fundamental values, driven primarily by investors’ reactions to news or market events. When such moves result in assets becoming overvalued or undervalued, they can create opportunities to sell or buy, in the expectation that prices will return to fair value.

But things move fast in the investment world. Many investors are now placing great value not just on the money they receive from their investments, but also on the non-financial influences related to what they invest in.

They are keen to expand their objectives beyond pure income and capital growth, becoming increasingly interested in the environmental, social and governance (ESG) standards of the companies they provide capital to.

Asset managers are therefore looking to offer them more ways to achieve those goals, including providing new funds that incorporate ‘responsible’ investing objectives.

Beyond exclusion

Responsible investing has developed rapidly in recent years. Before more sophisticated processes were created, fund managers may have merely excluded investments in companies that were seen to be violating certain ethical standards.

This developed into screening features, usually applying filters to impose limits on investments in certain industries, such as alcohol and tobacco.

Fund managers have taken this further, responding to demand to incorporate elements of being a “force for good” into their investment decisions. Some new funds embrace themes such as sustainability and a focus on the positive impact on the environment or society that companies can make.

Developments in responsible investing sophistication

Source: 2016 Global Sustainable Investment Review, GSIA. CAGR = compound annual growth rate. Past performance is not a guide to future performance.

As the above chart shows, the market for sustainability-themed and impact strategies grew at an annual rate of more than 50% between 2014-2016.

What is behind these strong growth rates? A 2017 Morgan Stanley survey found that 75% of individual investors, and 86% of millennial investors (those aged 18-35), were interested in sustainable investing.

A majority of millennials in the survey believed sustainable investing involves making a financial trade-off, yet they were still prepared to consider adopting the approach.

However, there is growing evidence that suggests the opposite to be true – sustainable investing could actually improve returns. In comments accompanying the survey, Morgan Stanley analysts said that large institutional investors are beginning to see that ESG factors provide unique insights into long-term risks and opportunities.

If the message spreads that responsible investing need not entail a financial trade-off, interest could build further.

Companies are recognising there are benefits, including financial ones, to operating responsibly and enhancing the standards they uphold. That could include reducing waste, curbing pollution and obtaining their inputs from sustainable sources. By being proactive, they may also be considered paragons of best practice and stay ahead of, or even help frame, the regulatory requirements of the future.

ESG and multi-asset

What many investors may not appreciate is that equities, or company ownership, are not the sole way to get access to ESG-related investing. Providing finance through lending – either by offering loans directly or by purchasing bonds – also empowers investors to insist on the pursuit of best practice as a condition of the funding.

This means expert ESG analysis can be as important a feature of multi-asset funds as it can be for equity and bond funds. It allows multi-asset investors to embrace ESG themes in their whole portfolios, while still enjoying the benefits of a blended approach, such as diversification by holding more than one asset class.

Asset management groups possessing sophisticated ESG expertise across a broad range of investment opportunities may be well-placed to offer investors multi-asset funds that capture a variety of responsible investing themes.

These opportunities could come from traditional equities, green bonds (securities issued for environment-friendly initiatives), infrastructure development for public good, and many others.

As responsible investing that incorporates strong ESG standards becomes increasingly integral to many investors’ objectives, asset managers able to combine asset allocation capabilities and ESG expertise effectively as part of their multi-asset product range may be in high demand.

Data: All data from M&G as of 17 August 2018. The views expressed in this document should not be taken as a recommendation, advice or forecast. This information is not an offer or solicitation of an offer for the purchase of shares in any of M&G’s funds.

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