Quintet's incorporation of environmental and social characteristics comprises a toolkit of approaches and dedicated assets. In this primer we deep dive into dedicated assets – arguably an investing strategy considering ESG factors which is designed to deliver a real-world impact.
Dedicated asset investors seek to identify financial instruments that are explicitly designed with ESG factors as a defining characteristic. Examples of popular dedicated assets are green bonds, multilateral development bank debt and microcredit (figure 1).
Investors deploying dedicated asset strategies typically seek either:
Dedicated assets are typically easy to identify as they are explicitly designed with ESG factors as a defining characteristic. The proceeds of dedicated assets can often be closely traced and there can be a direct link between sustainable outcomes and investment returns. Common dedicated asset characteristics include:
Dedicated asset construction will vary depending on whether the asset seeks to closely replicate a conventional sub-asset class or whether the dedicated asset delivers an exposure not found in other financial instruments.
For those dedicated assets that seek to closely replicate a conventional sub-asset, the dedicated asset’s construction may be constrained and constructed with reference to conventional methodologies. For example, green bond indices largely mirror the conventional index criteria for minimum issue size, currency and legal structure. In order to facilitate broad investor adoption such dedicated assets may also seek to replicate, to the extent possible, the conventional asset’s costs and legal structures.
For those dedicated assets that deliver an exposure not found in other financial instruments, their construction may be unconstrained and be a function of a unique set of circumstances. The construction may reference to local standards, regulations and commercial opportunities and can therefore lead to a higher cost of ownership and / or a more complex or innovative legal structure, which may restrict certain investor groups from investing.
Dedicated assets strategies can fund the transition towards a more sustainable economy, creating significant real-world impact. They may also diversify a portfolio and improve investor returns.
Dedicated assets enable investors to explicitly allocate capital to reflect their personal preferences, and typically have a large primary market component. When deployed in primary markets dedicated asset strategies can channel significant new capital to individuals, companies and nascent industries, helping them scale and achieve a larger positive impact.
Dedicated assets that seek close replication of a conventional sub-asset class by definition closely mirror that sub-asset’s investment characteristics. They therefore provide broadly equivalent risk and return characteristics and can substitute for the conventional sub-asset with relative ease.
Dedicated assets that deliver an exposure not found in other financial instruments can offer significant portfolio decorrelation benefits. Figure 3 shows the change in historic risk-adjusted return for a simple equity–bond portfolio with the addition of microcredit.
Dedicated assets that seek close replication of a conventional sub-asset class will predominantly exhibit the same portfolio characteristics as the conventional sub-asset class. However, deviations and tracking errors may still be present. For example, USD and EUR green bond indices have historically offered a more defensive issuer profile due to the greater prevalence of supranationals and agencies in the green bond market, relative to the conventional investment grade market.
Dedicated assets that deliver an exposure not found in other financial instruments can offer a range of idiosyncratic portfolio characteristics. While these will differ between dedicated assets, a frequent commonality is an illiquidity factor, as these investments may involve more complex or innovative legal structures.
Dedicated assets that seek close replication of a conventional sub-asset class may be active or passive. When the dedicated asset is clearly defined and largely homogenous, index creation and passive tracking is possible.
Dedicated assets that deliver an exposure not found in other financial instruments are almost exclusively actively managed. This is because they are often complex and heterogenous, and may have a degree of illiquidity.
Dedicated assets that seek close replication of a conventional sub-asset class can be benchmarked to an equivalent sub-asset class benchmark, either conventional or sustainable. For example, green bonds can be benchmarked to the Bloomberg Barclays Global Corporate Aggregate or a sustainable index, such as Bloomberg Barclays MSCI Global Green Bond Index.
Dedicated assets that deliver an exposure not found in other financial instruments often have no comparative benchmark or will target an absolute return in excess of the risk-free rate.
Investors can deploy dedicated assets strategies in their portfolios via single instrument selection or via fund selection (figure 4).
The risks of investing in dedicated assets that seek close replication of a conventional sub-asset class mirror many of the conventional sub-asset class’ risks. For example, dedicated fixed income securities will experience credit and duration risks, while dedicated impact private equity strategies will be affected by liquidity, cash flow and solvency risks.
However, there are additional specific risks:
AJ Singh, Head of ESG and Sustainable Investing,
Giang Vu, Sustainable Investing Strategist
Bas Gradussen, Sustainable Investment Strategist
Martynas Rudavicius, Sustainable Investment Strategist
Elena Meganck, Analyst
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 12 July 2021, 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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