We asked Richard Stroud, co-manager of the Close Sustainable Balanced Portfolio Fund, to answer the top 6 questions we get when it comes to investing in sustainable funds:
1. How do you define your approach to sustainable investing?
Our approach to sustainable investing is best defined through our process. We use an Ethical screen to address ‘what’ an entity produces, to exclude certain sectors or practices (such as fossil fuels and tobacco) which some investors are looking to avoid. Next, we use an ESG screen to address ‘how’ a company operates. The aim is to seek out companies with strong environmental, social and governance (ESG) credentials. In this sense, ‘sustainable’ does not exclusively apply to environmental considerations, but also reflects the preparedness of a company for wider ESG-related risks and opportunities.
2. What should advisers look for when selecting sustainable funds for their clients?
First and foremost, an adviser needs to truly understand the clients’ sustainability preferences to ensure that they are recommending a solution that correctly aligns with the clients’ values and expectations.
When selecting the fund, an adviser will need to understand the process and parameters by which the sustainable solution is run – again, to ensure that it aligns with client values and expectations. This might include scrutinising data sources, metrics and tolerance levels that the fund manager is implementing. Similarly, it is useful to understand why particular ESG or ethical data providers are chosen over others, and whether this would impact the holdings that qualify for inclusion. Methodologies used by ESG data providers are not consistent and can lead to drastically different outcomes when constructing a portfolio.
It’s also important to understand whether or not the investment management team is afforded any freedoms to develop or even overrule third party ESG data. If this is the case, are there checks and balances in place to scrutinise the inherent subjectivity of the situation?
It also helps to look at the investment house as a whole. Some questions to ask are: Is the company practicing what it preaches? Does it publish its voting policy and voting record? Is it a member of a sustainable or responsible investment initiative, such as the UN Principles for Responsible Investing (UNPRI)? Is there a firm-wide ESG policy? If the company itself has an ESG rating, what is it?
Crucially, consider partnering with an investment house that’s willing to help you navigate the nuanced world of sustainable investing. That could be by providing explanations as to why a stock is included within a portfolio, offering monthly insights or just being transparent and available to support you in providing the best possible experience for your clients.
Of course, the above is all in addition to the ‘usual’ considerations of suitability and appropriateness.
3. Does applying Ethical and ESG screens reduce your investment universe, making returns harder to find?
Naturally, the two sustainability screens (described in question 1) reduce the investment universe because we avoid certain sectors and practices completely, as well as investments with an ESG rating lower than ‘A’.
However, the reduced investable universe does not necessarily make returns harder to find. Interestingly, we’ve found a strong positive correlation between our proprietary quantitative valuation model upsides and ESG ratings. This means, on average, we see higher potential upsides in companies with better ESG ratings. Conversely, we’ve been seeing lower upsides opportunity in companies with weaker ESG ratings. In this sense, returns are not harder to find as our valuation model shows a preference for companies with strong ESG credentials, which is exactly what we seek to invest in.
4. With ESG/sustainable investing being so popular, are there too many investors chasing the same stocks and is this creating a bubble?
One could take the view that sustainable initiatives from governments, regulators and international organisations act as a structural tailwind for certain sectors and companies, which can help operational performance. If this results in a company with strong ESG credentials enjoying growth metrics above the peer group, or a lower cost of capital, then it’s clear to see why investors would want to hold it. Such companies arguably deserve a higher valuation, without entering into ‘bubble’ territory.
There’s also an argument to be made that ESG ratings between the research providers tend to share a low correlation. Compared to credit ratings for example, ESG scoring methodologies are still diverse, resulting in different views on the sustainability of a given company. This reduces the risk of investments becoming ‘crowded’, as it is still relatively subjective.
However, it is important to emphasise that we view valuations as equally important as sustainability considerations. Our proprietary quantitative valuation model acts as an anchor for valuations, and we have a minimum 15% upside requirement for equities in order to invest. As mentioned, we actually see higher potential upsides in higher-rated ESG stocks. For all of these reasons, we don’t currently see evidence of a ‘bubble’.
5. How do you source sustainable investments in Alternatives and how much choice do you have?
Managing a multi-asset fund, we recognise the importance of Alternatives within a portfolio; enhancing diversification and providing uncorrelated returns. However, the asset class itself is heterogeneous in nature, and as a result standardised ESG ratings are not available as they are for equities and bonds. To be able to offer a truly multi-asset solution for your clients, we take a thematic approach to the sustainability of our Alternative allocation. We break down the asset class into themes, such as ‘positive impact’ for the likes of infrastructure and property, which will include social housing and renewable energy. Where commodities are concerned, where available, we implement a theme of ‘responsible sourcing’.
6. How regularly do you review your existing holdings to ensure they continue to satisfy the Ethical and ESG criteria?
Holdings are assessed weekly to ensure they still pass the Ethical screen. For ESG, we receive immediate alerts of any rating changes. If a holding is downgraded below our minimum level of ‘A’, it will no longer be eligible for inclusion within the fund. In such circumstances, we have a 90-day limit to allow for an orderly selling of the holding, but will look to divest as quickly as reasonably possible.
To learn more about the Close Sustainable Balanced Portfolio Fund:
Important information
This article is only intended for use by UK investment professionals and should not be distributed to or relied upon by retail clients. The value of investments will go up and down and clients may get back less money than they invested. The information contained in this article is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This article is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.