Investing on the basis of ESG criteria has become a trend
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Demand is growing for ESG investments. What does this mean for asset managers?

More and more investors are considering ESG investments. However, their reasons for doing so vary greatly. This article explains how asset managers can cover their clients' specific needs, and what they should bear in mind when realigning an investment portfolio.

Wide range of motivating factors behind ESG investments

The demand for investing on the basis of ESG (environmental, social, and governance) criteria has spiked in recent years. This is partly because public awareness of environmental topics and the availability of ESG investment opportunities have grown. Furthermore, experience shows that sustainable investments can also generate attractive financial returns. From a regulatory standpoint as well, more and more transparency is being called for in view of ESG investments. Accordingly, asset managers must develop a strategy for implementing ESG themes in their investment process and service range. The information below can help external asset managers (EAMs) learn how to cover the wide range of client needs in this segment.

The reasons for including sustainability aspects in a portfolio management strategy can vary greatly from client to client. While some private clients refrain from investing in companies with controversial business practices, for instance, the next generation of a high net worth family may wish to incorporate their family values into the asset management process. Charitable foundations want to fulfill their purpose in an efficient yet effective manner, and feel that ESG is one way to align their goals with their investment activities. Pension funds, by contrast, might focus on the risk aspect of ESG investments. This means that asset managers who work with these clients must have an advisory process in tune with these goals and preferences.

Integrating ESG elements into an investment portfolio

Thanks to the rise in popularity of ESG investments and the wide range of reasons why end clients are interested in them, many asset managers need a strategy for navigating the ESG landscape and developing a service portfolio that meets different client requirements in this segment.

To cover the spectrum of client preferences, asset managers can turn to the Sustainable Investment Framework of Credit Suisse. This includes the three following core elements:

  1. Exclusions (avoiding loss)
  2. ESG integration
  3. Thematic and impact-aligned investing (impact investing)

ESG integration in the investment portfolio: Three core elements at a glance

1. Exclusions (avoiding loss)

Entire sectors and companies that are involved in controversial business practices are excluded from the investment universe. A distinction is made here among norms-based exclusions (such as controversial weapons), values-based exclusions (such as tobacco or gambling), and exclusions based on business conduct (such as human rights violations).

2. ESG integration

The objective of ESG integration is to make better informed investment decisions through the inclusion of insights on key ESG-related risks and opportunities in combination with financial analysis. Companies that integrate ESG practices actively into their strategic decisions are favored. After all, they are less susceptible to political or regulatory risks and reputational risks.

3. Thematic and impact-aligned investing (impact investing)

Thematic and impact-aligned investing can be used for clients to generate not only financial returns but also positive, quantifiable social and environmental results.

Various use cases for asset managers

Below we have outlined use cases for schematic client needs that require different approaches to a solution.

Case 1) Concerns about structural shifts in the economy

Because the client is concerned about market shifts, they are not focused so much on the ESG characteristics of the portfolio but rather on the right position for taking advantage of investment opportunities from the start and participating in the development. Appropriate solutions for integrating the client's preferences into this portfolio might be investment funds (such as investments in the new energy ecosystem) or a detailed analysis of the potential risks some securities might pose. Private equity is also an option for a longer-term investment horizon.

Case 2) Avoid weapons manufacturers in the investment portfolio

If the client's personal values conflict with a company's business activities, they may request that this type of company not be included in the portfolio. Thus, companies whose activities exceed a certain threshold (such as 5%) are excluded.

Excluding controversial businesses from the investment portfolio

Threshold for controversial business activities

Activities of companies that can be excluded
Source: MSCI, Credit Suisse

When making exclusions, remember that this can have an effect on the asset allocation of the portfolio and its risk/return characteristics, depending on the threshold and the economic importance of the business. Thus, after making exclusions, it is essential to optimize the portfolio in order to retain the desired characteristics.

Case 3) Make a difference with investments

If a client wishes to pursue a specific ESG goal with their investments, the first step is to determine the precise investment objective. Both financial and non-financial aspects should be considered. Because many ESG products do not have a quantifiable non-financial objective, they are not considered impact solutions. Example: reducing the amount of waste in the oceans. For this reason, it is important to always identify those products that meet the client's impact criteria.

Case 4) Minimize ESG risks in the portfolio

Businesses that are involved in controversies could see a decline in their share price. An in-depth analysis of the investment portfolio helps to identify such risks. This enables asset managers to advise clients on any risks, and to show them the distribution of traditional ESG ratings and laggards in their portfolio. The analysis may lead the client to switch to stocks with better ESG opportunities.

The distribution of an ESG rating in an investment portfolio

Example of ESG rating distribution in a portfolio

Laggards can be identified using a portfolio analysis.
Source: MSCI, Credit Suisse

Asset managers need to have a clear approach

In summary, a clear approach to integrating ESG elements into a portfolio is a key aspect in an asset manager's advisory process.

The three-level approach helps asset managers cover a wide range of client needs. For asset managers, it can also be helpful to involve ESG experts in the process when it comes to realigning a portfolio to sustainable investing.

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