ESG Investing – From Satellite to Core

February 2022 Monthly CiN-sights

The early January strength in major global equity markets, with the Dow Jones, S&P500 and the Stoxx600 all hitting new record highs, proved to be short-lived. Volatility returned as mounting inflation fears, hawkish central banks and geopolitical tensions saw major indices close lower for the month. The ASX200 and the S&P500 both had their weakest month since March 2020, falling 6.35% and 5.3% respectively. With inflation hitting multi-decade highs in the US, the Federal Reserve indicated a possible interest rate hike as soon as March. This move away from the most accommodative policy in history has raised concerns on risk asset valuations and the growth outlook.

With the market transitioning from an easing to a tightening cycle, asset classes and industry sectors are being repriced based on the new economic factors and expectations. Whilst we expect the market to gyrate, we retain our asset allocation calls for the quarter based on economic fundamentals. Please see our Quarterly Market Update – Q1 2022 for more.

In our Model Portfolio suite, we administer an ESG portfolio which is continuously being refined as the sophistication of the industry deepens and the more high-quality product becomes available. Here are our latest thoughts.

There was a time when environmental, social and governance (ESG) issues were the niche concern of a select group of ethically responsible investors. That time is long gone.

Client demand, government policy, central bank encouragement and regulatory requirements are all driving the investment profession to integrate ESG factors throughout investment processes.

One of the main reasons for ESG integration is recognising that ESG investing can reduce risk and enhance returns, as it considers additional risks and injects forward-looking insights into the investment process. Companies with strong ESG strategies are also better positioned to benefit from sustainability megatrends.

Another reason for implementing ESG stems from the recognition that negative megatrends will, over time, create a drag on economic prosperity as basic inputs (such as water, energy and land) become increasingly scarce and expensive, and the prevalence of health and income inequalities increase instability. There is an understanding that, unless these trends are reversed, the economies will weaken, and be ever more exposed to sustainability-led bubbles and spikes.

Examples of ESG Issues:

Of the three ESG factors, governance is the element most often taken into consideration by traditional investment analysis. A 2017 CFA Institute ESG survey showed that 67% of global respondents take governance into consideration in their investment process; ahead of environmental and social factors (both on 54%).

As of 2018, the largest sustainable investment strategy globally continued to be negative screening, with a combined US$19.8tn in assets under management. This is followed by ESG integration, which had grown by 69% over the prior two years.

  • Negative screening is the largest strategy in Europe.
  • ESG integration commands most assets in the USA, Canada, Australia and New Zealand.
  • Corporate engagement and shareholder action constitute the predominant strategy in Japan.

Responsible investment assets by strategy and region:

Most assets were allocated to public equities: 51% at the start of 2018; whereas the next largest asset allocation is in fixed income, with 36%.

Asset classes in global ESG investing (2018):

Various initiatives have also contributed to increasing the investment industry’s awareness of ESG, among these is the United Nations Principles of Responsible Investment (PRI). The PRI comprises an UN-supported international network of investors (signatories) working together towards a common goal to apply ESG to investment and ownership decisions.

PRI signatories have grown circa 30% a year since 2006. In April 2021, PRI asset owner signatories numbered 606 and managed aggregate assets of over US$31.2tn; the total number of signatories was 3,811.

This rapid acceleration of interest in ESG investing demonstrates the market opportunity for ESG, which is a major development that will shape the future of finance.

We expect ESG integration to become, if not already, a core consideration of investment portfolio allocation. Reach out to your Carnbrea adviser for the latest ESG Model Portfolio factsheet.

(Reference: CFA Certificate in ESG Investing Edition 3, 2021)

For further information and guidance, please contact us here.


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