Global Asset Tracker: Demand for sustainable solutions expected to grow

Clients interested in sustainability are of a long-term mindset and not put off by market volatility and oil price spikes

Increasing awareness of global climate challenges, and the associated investment opportunities, continue to drive investor interest in sustainable and impact strategies.

Wealthy families, led by younger generations, are keen to generate a positive impact with their assets, while often frustrated by the general lack of progress on many social and environmental issues.

Findings from PWM’s eighth annual Global Asset Tracker study show client demand for sustainable and impact investing is expected to grow further this year at most private banks.  The research, conducted in January, surveys investment and asset allocation intentions of chief investment officers (CIOs), heads of sustainable investing and asset allocation at 51 institutions, managing a combined $18tn in client assets.

“Clients interested in sustainability are aware their choices are long-term, and we have not seen change of appetite based on the contextual high performance of oil, gas and weapons,” reports César Pérez Ruiz, head of investment and CIO at Pictet Wealth Management.

At the global level, environmental, social and governance (ESG) solutions held up better than traditional investments. ESG funds experienced $16bn of inflows in 2022, while overall active strategies witnessed $465bn in outflows globally, according to Bank of America.

The climate crisis and reducing carbon emissions are the most important sustainability priorities for high net worth and ultra-high net worth individuals, while other related environmental topics are also high on their agenda.

Underperformance myth

The most important factor that could increase client interest is greater evidence that ESG and impact strategies do not underperform traditional investing, according to two thirds of respondents (see chart).

Yet, all empirical research so far shows there is no evidence of underperformance over the long term. Rather, these investments tend to outperform, as companies that manage their business and shareholders sustainably, and whose products and services address environmental and social challenges, are also likely to deliver sustainable financial results in the longer term.

“The myth of underperformance starts with the fact that ESG analysis is perceived as ideological and political, and is divisive,” says Erika Karp, chief impact officer at US-based wealth manager Pathstone. “The reality is that ESG analysis is a research discipline, giving more transparency and insight into potential risks and opportunities for businesses.”

The language and terms being used have led people to believe investors need to accept concessionary returns to do good, which is wrong, adds Ms Karp. Indeed, sustainable investing is a “proxy for quality, innovation and resilience, which imply long-term understanding of businesses and markets”.

Moreover, fund managers launching sustainable strategies may not have the right skills, which likely leads to underperformance, she warns.

Foundations have done a “disservice”, she adds. They have structured their assets, using sustainable and impact solutions for their mission investing only. However their internal funds have not been invested in this way, giving the false impression that these solutions generate below market rate returns.

That the ESG exclusionary approach leads to lower returns by reducing the investment universe is also a preconceived idea, she adds, stating that good fund managers, even if fossil fuel free, were able to outperform in a rising oil price environment.

Importantly, over the medium and long term, the underweight in fossil fuels and integration of ESG factors in general, proved to be an advantage, leading the MSCI World SRI index to significantly outperform its standard counterpart (see table).

Greater education

Improving client and adviser education is vital to increasing the share of sustainable and impact assets in portfolios, as is improvement in impact reporting. This must go hand in hand with identifying opportunities offering greater scale and establishing longer track records to drive growth in sustainable investing, says Harlin Singh, global head of sustainable investing at Citi Global Wealth.

“Increasingly, clients are more interested in thematic and impact strategies targeting the growing realm of solution-based investments in climate, healthcare and other sustainability focused areas, as they see these as potential areas of outperformance in the long run,” she adds.

They are also keener to understand sustainability performance, both from a financial and non-financial angle, recognising it varies widely, based on the type of investment they are targeting. “Additional work is required in understanding clients’ sustainability goals to garner investment interest, mapping these back to investable opportunities to accelerate growth,” says Ms Singh.

There is increasing need for clarity, uniformity, and accountability around ESG disclosures, comments Julien Lafargue, chief market strategist at Barclays Private Bank. This shows that “while returns are important, the impact of investments is also very closely monitored and a key factor in deciding to allocate capital,” he says.

Closer to clients

Other bankers acknowledge short-term underperformance has proved a setback for these solutions.

“For now, client demand is still relatively low,” admits Gonçalo Câmara Pestana, BPI’s head of financial advisory, private banking. “The fact that these themes underperformed last year didn’t help to attract more interest.”

Being close to clients is especially important at challenging times, explains Rodrigo Lima, chief investment strategist at Banco do Brasil Private. “We faced a difficult year for thematic investments and ESG, which required a dedicated workforce to answer questions and reassure investors,” he says, adding these solutions are essential for the financial sector’s future.

Transparent and honest communication about merits and limitations of sustainable investment approaches remain central to long-term growth, adds Christian Abuide, head of asset allocation at Lombard Odier.

“Some of these assets had become overvalued as a result of increased demand for thematic equities, back in 2020 and early 2021. Removing some of that froth is a positive and offers a more attractive entry point for current investors,” he says.

More structurally, Russia’s invasion of Ukraine further strengthens the long-term need for increased sustainable, clean energy production. Moreover, governments’ strong capital commitments toward sustainable goals – including the €300bn ($320bn) REPowerEU plan “to rapidly reduce dependence on Russian fossil fuels and fast forward the green transition”, followed by the EU’s €400bn green industrial plan, as a response to the $370bn US Inflation Reduction Act – has reinforced investors’ conviction that sustainability will be a key long-term driver of investment returns.

More progress towards common regulatory standards and data homogenisation would help further, according to respondents, while consistency in terminology would also be widely welcomed.

In Europe, regulation such as MiFID II, now including sustainability questions, is expected to have a longer-term impact on client flows into sustainable investing strategies.

Diversification benefits

A year like 2022 highlights the importance of portfolio diversification, across styles, asset classes and players, as much in the sustainable and impact investing space as in more traditional approaches, according to UBS.

Growth-oriented thematic strategies, such as electric mobility or digital health, and ‘ESG leaders strategies’, systematically underweighting energy or tilted toward more growth, underperformed. But pockets of outperformance were found in US ‘improver’ solutions, or strategies focused on gender equality, while defensive themes also held up well.

“Investors should not neglect more value-oriented long-term ideas in the sustainability space,” says Solita Marcelli, CIO Americas at UBS GWM, who suggests value-oriented opportunities can be found in food supply chains, waste management, and recycling.

“Clients need to understand they can find sustainable investments across many asset classes and focus areas, each of which performs differently and may have its own benchmark.

“Building diversified portfolios of sustainable investments across asset classes can help mitigate dependency of overall performance on short-term returns,” adds Ms Marcelli.

Survey respondents, who mainly use sustainable and impact solutions in equities and fixed income, would like to see a wider range of these solutions, across all or some specific asset classes, such as alternatives. Greater choice of investments would help speed up the process of making these solutions the preferred investments in client portfolios, with plenty of room for growth.

Sixty per cent of respondents estimate that only 10 per cent of client assets, or even less than that, will be generating a positive impact on the environment or society by the end of next year, with 16 per cent believing it will be more than 30 per cent.

Thematic and impact funds do attract client interest, according to most survey respondents, because they can relate better to them.

Shades of green 

While dedicated impact funds remain a smaller part of allocations, there has been an increasing focus on strategies with sustainable objectives for investments or addressing a specific issue. These are classified as ‘dark green’ funds, according to EU regulation.

All other fund sectors have been suffering outflows over the last year, including ‘light green’ strategies, says Muriel Danis, global head of product, platforms and sustainable solutions, Deutsche Bank International Private Bank. “This shows clients have a growing interest in more thematic strategies, which may also resonate better with their own preferences,” she says, pointing to popular themes such as renewable energies, circular economy, or the sustainable blue economy.

An even brighter future awaits impact and sustainable strategies, as investors recognise these solutions can help them address complex global environmental and social problems, while more consistent ESG classifications and data will help them make more informed decisions, says Deutsche Bank Private Bank’s ESG CIO, Markus Müller.

Moreover, as investors pay more attention to the broader concept of risk, such as physical and transition risks linked to the climate crisis, rather than focusing on short-term returns only, preconceived ideas around underperformance of impact funds will also fade away. “As a result, the altruistic case for impact investing funds, and ESG in general, is likely to be increasingly supported by practical portfolio management considerations.”