The right tools: is it possible to build a balanced ESG portfolio?


Panel discussion, hosted by Cherry Reynard, with:
Jake Moeller – Senior Investment Consultant, Square Mile
Ben Constable Maxwell – Head of Sustainable and Impact Investing, M&G Investments
Toby Gibb – Global Head of Investment Directing, Fidelity International

Just in case anyone still thought that ESG was a fad, 2020 showed otherwise. Fund flows quadrupled in 2020 over the previous year, new regulatory initiatives came to the fore, while policymakers have made it clear that ‘building back better’ would include huge commitments to green energy.

This growing momentum is difficult for advisers to ignore, not least because MiFID II rules will shortly compel them to ask clients about their sustainability preferences. However, there are still some difficulties in building balanced ESG portfolios for clients, from the lack of risk-rated multi-asset funds to limited choice in fixed income and alternatives. Do advisers really have the tools to build a balanced ESG portfolio?

There were a lot of new launches in 2020, aiming to meet the growing appetite for environmental and sustainability solutions. However, many of them have been focused on global equity or on carbon transition. The logic is clear: on carbon disclosure, for example, disclosure by corporates is generally good and it is relatively straightforward for fund managers to measure and target.

For those wanting fixed income or alternatives exposure, there are fewer options. Toby Gibb, global head of investment directing, Fidelity International, says: “When investors move out of equities, there are certainly some gaps. Fixed income, for example, has been late to the ESG party to some degree, partly because fixed income doesn’t have the natural equity power. There isn’t the ability for proxy voting or engagement.”

Green bonds were a significant feature of this year’s budget and there has been a lot of issuance this year. There have been a number of green bond funds launched and more choice is emerging. Gibb admits there are still some issues: “It’s not perfect. It’s a relatively small universe of securities, therefore liquidity isn’t great. Governance and bond issuance is not standardised, which makes investors quite cautious. There is also debate as to whether there is a premium for these bonds.” However, it looks like there is progress on green fixed income.

Real estate lends itself well to sustainable investing and Gibb says Fidelity has done a lot of work in this area. However, areas such as absolute return are likely to take longer to go green. Gibb says: “Should you short poor ESG companies? Or should you have no exposure? No one quite has the answer yet.”

Multi-asset has been one of the biggest gaps, particularly risk-rated multi-asset. Ben Constable Maxwell, head of sustainable and impact investing at M&G Investments, says fund managers recognise that sustainable, ESG and impact products need to expand beyond single-asset class funds. He says: “Fund managers recognise multi-asset is an area that’s been underserved and we need to up our game. For a couple of years we’ve managed a sustainable multi-asset fund, which has a best-in-class, sustainable ‘tilt’ with a strong emphasis on engagement and a basket of positive impact investments. We have recently taken that experience and developed a range of risk-rated portfolios.”

M&G is not alone.  Jake Moeller, senior investment consultant at Square Mile, says there have been a raft of multi-asset product launches more recently as fund managers have responded to gaps in the market. He adds: “Fund managers realise that ESG is no longer just the 3% of flows that used to go into ethical funds. They are becoming increasingly aware that they need to bring more robust products to market. Products are being rebadged, a number of products are coming to market that have responsible mandates and we’re seeing a lot more talk about ESG integration at group-level.”

Fund management groups are also providing more information. Moeller says the data emerging is clearer and should get even better as there is greater clarity on definitions and more reporting by companies. This should help analysts provide clearer and more detailed ESG assessment for funds, which will ultimately help advisers.

The current situation is imperfect. There is still a lack of choice in non-equity funds with ESG, sustainable and impact goals. However, the industry appears to be evolving quickly to meet demand. Watch this space.