Our sustainable investment approach starts with an understanding of the broader market environment. This contextualises our investment philosophy, toolkit, approach to asset allocation and instrument selection (figure 1).
Sustainable assets have increased rapidly in recent years. According to Morningstar, as of December 2021, global sustainable assets stood at USD 2.74 trillion, almost triple the December 2018 figure. The pace of growth and innovation continues to accelerate, as the number of sustainable funds launched in Q4 2021 is almost double that of Q1 2019.
Investor interest is growing, especially following the global pandemic. A survey of families, foundations and individuals found that they increased their portfolio allocations to sustainable investing during the pandemic to an average of 36% in 2020, up from 20% in 2019.
Over medium- and long-time horizons sustainable funds have generally outperformed their conventional counterparts, this was especially true in 2020–21. For example, according to Morningstar, in 2021, 66% of US sustainable funds outperformed conventional market indices. Meanwhile, the commonly referenced MSCI World Socially Responsible Investment (SRI) Index has outperformed its conventional counterpart, the MSCI World Index for each of the last six calendar years (figure 2).
The growth of sustainable finance has triggered a regulatory response, which will likely encourage more flows into sustainable assets. For example, the European Union Sustainable Finance
Strategy aims to reorient capital flows to finance sustainable growth. The UK’s sustainable investing roadmap seeks to green the UK financial system and align it with a net-zero commitment.
Meanwhile, the Securities and Exchange Commission has proposed climate-related disclosures for US companies, which will provide more consistent corporate disclosure for investor
Sustainable investing is at the core of our investment philosophy and our default investment proposition. We believe that understanding material environmental, social and governance (ESG) factors improves the investment decision-making process and can lead to better returns. This is supported by several academic studies, which show evidence of boosting investment returns when incorporating ESG factors. Sustainable investing can also create value for investors beyond investment performance as they can align their own values and beliefs with their investments.
When pursuing a sustainable investment strategy, we predominantly follow a principle-based philosophy as opposed to a rules-based philosophy (figure 3). Principle-based philosophies view sustainability as a toolkit that can enhance the investment process. Investors seek to embed sustainable insights into their investment approach in order to expand the dataset used for investment decisions. This can lead to more informed choices and extended opportunities.
On the contrary, rules-based philosophies treat sustainability as a series of check boxes.
Investments must “pass” the rules and tests in order to be investible. Adopters of this philosophy typically rely on numerous exclusions, which restricts the investment universe and lead to reduced investment opportunities.
We recognise that sustainability is not binary and a variety of investment strategies can be created to exploit sustainability's investment potential, each with different investment characteristics. We describe the diversity of our investment approach as a toolkit, which contains strategies such as leaders, improvers, themes and dedicated assets (figure 4). Each approach provides a framework for the integration of sustainability factors at security level and can be implemented either standalone or in support of portfolio construction and risk management.
Leader strategies seek to invest in companies with the strongest sustainability practices. Investors deploying leader strategies expect fewer adverse events – such as accounting scandals. They believe that a holistic approach to business will generate improved cash flows through factors such as increased customer loyalty, greater employee productivity and collaborative supply chain partners, ultimately leading to better financial performance.
Improver strategies seek to invest in companies that are exhibiting positive momentum in their sustainability practices. Investors using improver strategies expect sustainability improvements to correlate to, or cause, improved operational performance. By identifying momentum ahead of other investors, they believe investee companies will deliver improved cash flows and may re-rate to a higher equity multiple, or a tighter credit spread. Investors may attempt to catalyse the improvement through active ownership; engaging company management through dialogue and voting in order to improve business practices and financial performance.
Thematic investing seeks to identify companies that are well-positioned to take advantage of significant secular growth trends currently underappreciated by the wider market. Investors deploying thematic strategies expect that companies exposed to these trends will have the potential to grow their revenues and cash flows faster than their competitors, commanding higher valuation multiples and leading to attractive returns for investors over a multi-year time horizon.
Dedicated asset investors seek to invest in financial instruments that are explicitly designed with sustainability as a defining characteristic. Dedicated assets are either close replications of a conventional sub-asset class, such as multilateral development bank debt having similar financial characteristics as AAA-rated government debt, or they offer significant decorrelation benefits with unique exposure, such as microcredit.
These approaches harness various factor tilts (figure 5). When used together multiple risk premia can be harvested and sector and factor biases can be partially mitigated. For example, the popular leader approach often creates large capitalisation and quality biases. Building portfolios with the improver approach can enable a portfolio to partially capture the value factor. In some cases when improvement is linked with active ownership, improver strategies may also exhibit an emerging market and/or mid-cap tilt, which also provides additional diversification benefits. Themes often favour companies that are smaller and have higher growth, while dedicated assets include both close replications of conventional sub-asset classes as well as unique assets that offer significant decorrelation.
A robust sustainable investment strategy involves incorporating sustainability throughout the asset allocation process. As a first step we incorporate sustainability considerations into our economic forecasts that in turn guide our capital markets assumptions – our long-term views on asset class risks and returns.
As a second step we make informed decisions about which sub-asset classes should comprise our multi-asset portfolios. Due to a combination of investment and sustainable considerations we opt not to allocate to commodities, with the exception of gold.
As a third step we utilise our sustainability toolkit and knowledge of the market environment to determine the optimal sustainable representation of each sub-asset class (figure 6).
We believe that sustainable markets are deep and liquid enough to fully replicate a globally diversified asset allocation portfolio using sustainable assets. For example, conventional gold can be sustainably represented by recycled gold. Recycled gold has the same financial characteristics as conventional gold but exhibits a carbon footprint that is 20 times lower.
When selecting instruments to populate the asset allocation framework, we ensure that each one meets our financial and sustainable expectations.
When investing directly in bonds and equities, we embed sustainability in every step of the process. We apply selected exclusions to ensure minimum responsible standards are met when defining the investment universe. Material sustainability factors are integrated into fundamental research to enrich idea generation and improve the accuracy of valuations. Portfolio modelling incorporates sustainability principles, seeking to improve the risk/return profile. Finally, we fulfil our fiduciary duty and further improve portfolio risk adjusted returns through making informed voting decisions and engage with company management.
When investing in third-party funds, we work closely with external fund managers to communicate our sustainable investment approach and expectations. Our dedicated fund selection team assess the fund’s elements such as its objectives, holdings and the fund manager’s capabilities, resources and the transparency of reporting. This process delivers the choice of funds that meet our requirements for both financial performance and sustainability.
Active ownership, which includes voting and engagement activities, forms a crucial element of sustainable investment by influencing change at the companies and external fund managers. Our 2021 active ownership activities are summarised in our Active Ownership report.
We operate with open architecture to ensure we capture the full talents of the investment industry, regardless of firm affiliation. Where solutions are not yet available, innovation inspires our instrument selection. We develop industry firsts in order to offer clients unique experience and investment options. Options for product innovation may include, but are not limited to, seeding third- party managers; operating an own management company vehicle but outsourcing the investment management to a third party, and creating in-house products. Non-product innovation may include, but is not limited to, supporting new collective engagement groups, supporting policy development, or non-governmental organisations.
Sustainable investing is at the core of our investment philosophy and our default investment proposition. Our sustainable investment approach is an investment philosophy that seeks competitive risk-adjusted financial returns while also doing good for people and the planet. We start with an understanding of the broader market environment, which contextualises our opportunity- focused investment philosophy and our diverse return-seeking toolkit. We are then able to incorporate sustainability throughout the asset allocation process and drive our sustainable approach into portfolios via innovative instrument selection.
This document has been prepared by Quintet Private Bank (Europe) S.A. The statements and views expressed in this document – based upon information from sources believed to be reliable – are those of Quintet Private Bank (Europe) S.A. as of 2 May 2022, and are subject to change. This document is of a general nature and does not constitute legal, accounting, tax or investment advice. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down.
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