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Avoid ESG tail risks to help generate alpha, study finds

Risk_optionsAvoiding environmental, social and governance (ESG) tail risks helps generate alpha over a full market cycle – more so than tilting a portfolio towards top ESG ratings – and active management is crucial to the process.

According to research carried out by Frankfurt-headquartered Allianz Global Investors (AllianzGI), ESG matters for downside risks. “Portfolios skewed to a worse ESG risk profile can show significantly more financial portfolio risk versus the benchmark,” the firm said.

Investments with a higher ESG risk scoring delivered a very similar risk profile when compared with the benchmark. Yet this is not the case for low ESG risk-rated portfolios.

The research suggests that there is a need to “address ESG as a source of tail risk through fundamental research and active management”.

Indeed, AllianzGI believes that active management is key when it comes to ESG. The firm is also an advocate of stewardship – a sentiment shared by Dutch fund manager Robeco and UK-based consultancy firm Alpha FMC.

In terms of actually making a difference through investing, Robeco’s head of ESG integration, Masja Zandbergen, referred to a study which “shows the mechanisms of how engagement – active ownership from shareholders – can actually lead to change in companies”.

“Being a big shareholder helps, so that's why I would be very happy if the big shareholders actually start to also do profound things in this area,” she told Funds Europe.

Despite Robeco not being a big shareholder in many of the names it engages with, there are still means to steer companies toward a more ESG-oriented direction, she said.

The Dutch firm might share best practices, demonstrating what others in the industry are doing, or act “a little bit like a free consultant” sharing “knowledge they don’t have, and they can use it internally to make change”.

However, not all engagements are successful, she said. “The company needs to be open, you need to have done the research. You have to spend lots of time and effort, and then maybe you can achieve something.”

For Vanessa Bingle, Alpha FMC’s co-manager of its ESG proposition, active engagement is “a really important part of the investment process”.

“There’s a scaling up based on your ambition as a firm, and also the practicalities of what your investment philosophy is and what's your holding period, for example,” she said. “There'll be different levels of active engagement that will be appropriate for different managers.”

If managers are taking engagement seriously and have the “power to engage with those companies”, they should do so, she said.

According to AllianzGI, investors need to be on the ball when looking at ESG factors such as “constantly changing macro and regulatory dynamics, as well as corporate fundamentals, market and political events”.

To fully address ESG risks, there are a host of ESG factors that investors must pay attention to in the future, including “constantly changing macro and regulatory dynamics, as well as corporate fundamentals, market and political events”.

Steffen Hörter, AllianzGI’s global head of ESG said: “We are convinced that active managers who make a judgemental risk/reward trade-off on ESG risks will prove their worth to investors, in comparison to the simple ESG portfolio tilts we have seen in the passive investment industry.”

Performance impact of active stewardship through corporate engagement and proxy voting may be “hard to measure in the short term”, but “there is good evidence that it adds value in the mid-term”.

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