Sustainable investing continues to gain momentum, with a recent Schroders study revealing that 56% of Australian investors would feel positive about shifting to a sustainable portfolio.* Our portfolio managers Simon Doyle (Head of Fixed Income and Multi-Asset), Stuart Dear (Head of Fixed Income) and Martin Conlon (Head of Australian Equities) discuss how professional investors are constructing their portfolios and integrating ESG considerations into their investment processes.
When it comes to ESG integration, as there’s no ‘one size fits all’ approach across different asset classes, how can investors get both sustainability and returns from their investments?
Simon Doyle, Head of Fixed Income and Multi-Asset:
The recent Schroders Global Investors Study showed there’s a big disconnect between return expectations and the level of yield, interest rates and market valuations. So, first and foremost, we need to think about how we can close that gap in terms of managing expectations, but also in terms of generating the sort of returns that investors are comfortable with, commensurate with their risk preferences.
My challenge as a multi-asset investor is to deliver what clients expect. Sustainability, in all its various dimensions, is part of the solution given its impact on returns and risks across the board. In a way, we’re a bit like a client – we construct multi-asset portfolios that invest across a raft of different assets classes, from equities through to corporate bonds, government bonds, currencies and private markets. Therefore, we need to consider sustainability across different assets and at every level of the portfolio construction process.
Asset allocation makes the most difference to return and risk outcomes. We’ve adapted our core framework to ensure sustainability is integrated into our return and risk forecasts, particularly regarding climate change, because the research highlighting the impacts has really improved and given us that opportunity.
How does ESG integration assist with the assessment of securities for portfolio allocation?
Stuart Dear, Head of Fixed Income:
Integration involves incorporating ESG factors into our investment process, embedding ESG into our return and risk assessments. You’ve got to be really holistic across different asset classes from an allocation viewpoint, from the top down as well as bottom up. It’s the same approach that we take in fixed income – it’s a very holistic and thorough approach.
For example, the assessment of sovereigns in the fixed income space is very nuanced. Governments leave a very broad footprint on society, and how can we measure the value of that? This is where we draw on our great global resources. Our global sustainability team have developed a proprietary tool called Sovereign SustainEx which calculates the net value to society of a government’s ESG interactions.
Looking at the calculation for Australia across the different components, SustainEx says the government, across all its ESG interactions with society, is adding around 0.5% to GDP. The breakdown shows that at the sovereign level Australia performs badly around the environment and carbon emissions, but we’re good in terms of institutional credibility, social and political stability, and the education system.
Sovereign SustainEx allows us to identify countries that are underpriced for ESG risk and is a very useful tool when it comes to making relative interest rate decisions between countries.
What role does sustainability play in stock selection?
Martin Conlon, Head of Australian Equities:
As a starting point, sustainability should be a generic term applying to all sectors and all companies. The economy is a complex mix of sectors, most of which are essential, therefore we need to address sustainability in all of those sectors.
It’s wrong to exclude the high emitters because, particularly in Australia, they represent larger parts of the economy since they’re providing significant resources for the global economy.
The fact is that they are essential, but they have to do better. We’re clearly not solving that problem if we exclude them from portfolios. The big emitters are by definition the ones that need to take the biggest steps if we’re going to get to net zero.
The BHPs and Rios of the world are doing as much as anyone to reduce their emissions because they know they’ve got the most to lose. That’s why we’ve taken the approach of not excluding companies. We want to value them and assess the approach every company is taking to ensure their cashflows are sustainable. This is better than adding up the emissions of a portfolio which, for some reason, has become an acceptable methodology.
We’re not delusional enough to think that in isolation we’re making a massive difference. All we can do is contribute to the change and contribute to the pressure by actively engaging with boards and companies about what they’re doing.
The issues involved are broad-ranging and they’re not just climate-related. For example, executive pay is one that comes up a lot. It has expanded massively versus rank and file wages over the last 30 years.
We need to stop this happening. We need to stop executives profiting by pressuring the wages of the rest of the business. We’re actively engaging in a more nuanced way because it’s hard to take a blanket approach as every company has got different sustainability issues.
*Schroders Global Investor Study 2021