Adam Gillett, director and head of sustainable investment at Willis Towers Watson, sets out the tools and strategies to put sustainable investment into action across portfolios.
Awareness around sustainable investment has grown significantly to a point where it can no longer be ignored. Yet what is still often lacking is clear and practical guidance on how it can be effectively achieved across portfolios. Ultimately, sustainable investment is about improving investment outcomes – achieving better returns and lower risk. So what can be done to put this into practice?
A greater array of available tools and strategies has made integrating sustainability into an investor’s portfolio an easier process than it has ever been before. Here are some of the ways to ensure that investors are meeting their sustainability needs, whilst mitigating previously unrecognised risks or targeting new opportunities to add return:
Assessing portfolio ‘resilience’ means evaluating the total exposure of a portfolio to a range of sustainability issues, across different asset classes, public and private markets, and identifying which are the most material to businesses, regulators and wider society. The exposure of various asset classes to these risks can then be mapped, incorporating ESG ratings alongside unstructured big data, to give a score relative to portfolio benchmark.
This is useful because a portfolio achieving a high resilience score should be less impacted by disruptive sustainability trends over the long term, where resilience can be evaluated in absolute terms or relative to a benchmark. In turn, this can lead to better asset allocation decisions, as resilience scores can provide a high-level guide to tilting capital allocation to (or from) areas with higher (or lower) scores.
With risk factors covering a wide range of issues - including employee rights, transparency and geopolitical events – it’s possible to get a good sense of what really matters in terms of sustainability.
Similarly, running climate scenarios across portfolios to gauge environmental impact can help understand how they may perform under different states of the world, both favourable and unfavourable. This involves considering physical risks, the risks from a transition to a lower-carbon economy and how these are impacted by the action (or inaction) of global policymakers.
Further, sophisticated reinsurance modelling tools can be applied to investment portfolios to estimate the exposure of individual assets and the total portfolio to a variety of physical perils, such as floods, wildfires and cyclones. This spatial technology analysis can easily be aggregated across different assets or funds and compared with benchmarks or peer groups. More detailed analysis allows the estimation of the value at risk for individual assets or the portfolio, which calibrates risk in dollar terms using a metric that is familiar to investors.
Integrating sustainability into core listed equity mandates is a key step for many investors. Using tools, such as the MSCI Adaptive Cap ESG Universal Index, can help to create a highly diversified, low-cost portfolio that spreads capital and risk more evenly between stocks compared to a traditional indexing approach. The index increases the weightings in companies with strong and improving ESG attributes, and excludes a small number of companies that fail to meet minimum ESG standards. This means that investors retain the ability to proactively engage with the vast majority of individual companies to drive positive change.
Private markets have long been an area where investors can express more thematic and targeted views, and are ripe for sustainability. There are a vast number of assets, which are compelling investments in their own rights, supported by long-term sustainability trends, but as a set benefit further from having attractive societal and environmental impacts.
Examples include advanced greenhouses for more sustainable agriculture, Energy from Waste electricity generation, temporary accommodation for vulnerable adults, specialist social housing for disabled people, cyber security, climate resilience through reinsurance, as well as the well-trodden paths of renewables investment in solar, hydro and wind power.
Stewardship is a key pillar of sustainable investment, although it can often be overlooked in favour of what are sometimes more immediate and tangible results. Good stewardship should protect and enhance the value of assets, and consequently is a critical part of a well-functioning investment process. Savvy investors should look to have stewardship integrated across their portfolios and leverage it beyond its historic focus on listed equities and voting; more time ought to be spent giving stewardship greater weight as a whole, and focusing on resources corresponding to its importance and value.
Of course it may be unrealistic for some investors – outside of the largest and best-governed ones – to move the dial on stewardship of their own accord. In many instances, collaboration and effective partnerships will instead be key. There have been a host of initiatives in this area over recent years which offer a way for the investment industry to express its collective voice with greater impact and reach. Investors can also partner with specialist stewardship providers, across corporate engagement, voting and public policy issues.
Another crucial element for participation comes from asset owners holding fellow industry members to account on their stewardship activities, particularly those which they delegate to their asset managers. Some managers already recognise the need to improve in these areas and have acted accordingly and this improvement needs to spread across indexation, active, equity, bond, real asset, listed and unlisted.
Overall, managers need more stewardship resources, greater clarity of objectives, further collaboration, leadership-minded thinking, and to make the most of the tools available to them. Asset owners, for their part, must be equipped to engage them on this journey, set out expectations, encourage best practice and hold managers to account when they do not deliver.
While there continues to be a wide-ranging conversation around sustainability, this talk does not always translate into action. By implementing some of these practical steps and getting to grips with the tools and strategies which are now available, investors are now able to meet their sustainability needs and improve investment outcomes across different portfolios.
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