Ethical strategies blossom amid health crisis

While the climate crisis remains the defining challenge of our time, the disproportionate effect of Covid-19 on society’s most vulnerable segments has proved a harsh wake-up call. As a result, investors have been forced to think about how to build a more sustainable, resilient and inclusive world. Their resulting vision, based increasingly on values and purposes, has embraced a desire to invest with impact.

“The global health crisis, social unrest and extreme weather events across the world have significantly changed the way we live our lives and think about the future, impacting the way our clients are looking at their investments and their financial legacy,” says Lily Trager, director of impact investing at Morgan Stanley Wealth Management. 

“This has really accelerated client interest in using their personal wealth to meet not only their financial goals but also to make a positive impact in the world.”

This trend reflects growing confidence that companies with better environmental and social characteristics are higher quality and more resilient firms, which may outperform on a risk-adjusted return basis, particularly during periods of market volatility.

Indeed, sustainable strategies weathered the storm better than conventional peers during the crisis, according to the Morgan Stanley Institute for Sustainable Investing, validating similar findings over the longer time horizon, and further dispelling the myth that investors who include sustainability considerations in their portfolios face a financial trade-off. 

 “We believe investors can achieve market rate returns across the entire continuum, from restriction screening to ESG integration, thematic exposure and impact investing, generating net positive, measurable outcomes for the society,” states Ms Trager. The bank’s Investment with Impact Framework, launched in 2012, offers clients the possibility to invest along these four major approaches. 

Rebalancing E with S

Over the past couple of years, the growth in sustainable investing has been focused on environmental topics, with strong growth in investments linked to climate change and in environmentally sustainable industries, such as renewables. 

This is because it is often easier to obtain environmental data to factor into financial assumptions, than it is with social data, explains Rachel Whittaker, sustainable investing strategist in the chief investment office of UBS Wealth Management.

By laying bare and exacerbating structural inequalities in society, the pandemic has brought a greater focus on social issues. Companies’ responses to the public health emergency are being carefully scrutinised, with investors punishing companies for bad behaviour, such as abuses of human rights, and generally for not supporting their employees throughout the entire value chain.

“While governance has been a core part of investment decision making for a longer time, the environment really dominated social and governance prior to the pandemic. But post-Covid, social has risen in relevance and all three ESG factors are now more equal, in terms of investors’ focus,” says Ms Whittaker. 

This year was the first time that the climate crisis and related environmental issues were ranked as the world’s top five risks in terms of likelihood by the World Economic Forum’s network of business leaders, NGOs and academics. 

“That is where the hearts and minds of our clients were, in terms of the desire to direct capital to solving environmental problems,” says Marisa Drew, chief sustainability officer at Credit Suisse, recalling the Davos Forum early in 2020.

Then the pandemic hit. The call was that sustainable investing would be given a lower priority, as people were grappling with the immediate crisis, and that environmental issues would take a back seat in favour of social issues. In fact, the amount of assets flowing into sustainable funds has accelerated and environmental issues, rather than being relegated, are now more in balance with the desire to invest to solve social issues, says Ms Drew. 

Covid Lessons

People have learned the hard way that it is crucial to prepare for risks, even those considered black swan events. Like the pandemic, the climate crisis may have felt distant and not urgent, but people have finally realised that its effects are going to be much more devastating.

Moreover, regulatory intervention and political desire to accelerate the transition to a low carbon economy are creating “very attractive” investment opportunities in the climate sector for private investors, ranging from electric vehicles to green hydrogen production. 

Many state budgets around the world are being allocated to promoting and accelerating investment in new technologies and green infrastructure, with the goal of building back better. 

Despite current clashes with Poland and Hungary at the time of going to press, the EU agreed on a revamped €1.8tn seven-year budget and recovery plan, including a commitment that 30 per cent will be spent on fighting climate change, which is the largest share of the largest European budget ever.

In the US, president-elect Biden has already confirmed that the US will rejoin the Paris Agreement, the multinational pact to combat climate change, and commit the country to a net-zero emissions reduction target by 2050. He has also laid out a $2tn clean energy and infrastructure plan.

The pandemic has also shown the interconnection between environmental and social issues. “People used to think of the E and S in different silos, but Covid has changed that perception,” says Ms Drew.

Scientists warn that Covid-19 is intrinsically linked to the world’s climate and biodiversity emergency, largely caused by human activities and destruction of necessary ecosystems. This is pushing animals out of their natural habitat, favouring the cross of pathogens from wildlife to humans. And with global warming and habitat loss, the risk of future pandemics is likely to increase.

Links between environment and social issues are also highlighted by several studies, including one by Harvard TH Chan School of Public Health, which shows an association between long-term exposure to air pollution and higher Covid-19 mortality rates.

“There is a recognition that climate change will disproportionately affect the lowest economic strata of society, just like we are seeing with the pandemic, and if we don’t start bridging inequalities, by not only investing directly to solve social issues, but also protecting the environment, these inequities are going to be exacerbated,” says Ms Drew. 

This increased awareness among wealthy clients is fuelling an emotional response to take action.

Clients want to shift more money into sustainable investing, and “rich discussions” are held to identify suitable investment solutions to cover specific themes they most care about, be it climate solutions, healthcare access for the under privileged or ocean conservation.

“The breadth of investment solutions that exist today cover many sectors, but we need more opportunities that align with the objectives of investors, across asset classes and themes,” says Ms Drew. 

She adds that despite all the enthusiasm, there still is a very large swathe of their client universe that is only beginning the sustainability journey, and want to do it “cautiously and slowly”.

Preferred solutions

While recognising that conventional investments will remain most suitable in some circumstances, UBS, the world’s largest wealth manager with more than $2.8tn in client assets, announced in September that it is recommending sustainable over traditional solutions for private clients investing globally, typically for discretionary portfolios. 

This means sustainable solutions will be the first strategies that advisers will discuss with global clients, explains UBS’s Ms Whittaker.

This far-reaching recommendation follows the launch three years ago of UBS’s fully diversified, sustainable discretionary portfolios, which today hold more than $15bn in client assets, and 25-year track record in sustainable investing. 

ESG mandates reflect the conviction, supported by years of historical data on ESG returns, that a sustainable portfolio can deliver similar or potentially higher returns compared to traditional investment portfolios and offer strong diversification for clients investing globally. The pandemic-caused market volatility provided an additional test, which sustainable solutions passed with flying colours, says Ms Whittaker. 

Today, the Swiss bank manages close to $500bn in core sustainable assets, primarily in equities and fixed income, ranging from engagement approaches in equities, to multi-lateral development bank bonds, to strategies that are aligning with clients’ specific values or sustainability goals. 

While sustainable solutions in the past were primarily focused on long only equities, there is now an extremely strong, potentially faster growing market for sustainable fixed income approaches, says Ms Whittaker. 

New sustainable approaches are now also emerging in alternative asset classes, with more activity seen in hedge funds, structured products, and in private markets, and capacity of investment strategies is expanding. While the global bank does not include alternatives in its core sustainable approach yet, it has a “strong offering” for advisory portfolios in impact private markets, primarily focused on private equity. 

The recent announcement did not create “any overnight change” in the bank’s long standing and comprehensive training programme with client advisers around sustainability, but it did give that “top down stamp of approval” on sustainability, making all advisers realise that sustainable investing has really entered the mainstream, explains Ms Whittaker. This “bold step”, taken by such a big, traditional organisation, may lead other market players to choose sustainable investing in their core product range, she hopes.

This is where the industry is heading. In Europe, the Sustainable Finance Disclosure Regulation (SFDR) expected to come into force next year, will require private banks, wealth managers and advisers, to comply with new rules on disclosure about sustainable investments and sustainability risks. 

These will involve incorporating client sustainability preferences in their processes and explaining their sustainability activities. The new regulation will force financial advisers to become more knowledgeable, competent, and credible to talk to about sustainable investing, raising the bar for the entire industry, where too many firms have embraced sustainability mainly for marketing purposes. 

Shared values

The pandemic has prompted many wealthy individuals to reflect more on their lives and priorities. The number of family discussions around values and purpose of wealth have significantly increased, spurred on by the heightened sense of mortality due to the healthcare emergency, as well as the intergenerational closeness imposed by the lockdown.

The influence of younger generations, who are generally more sustainability conscious, strong inflows into ESG funds and their resilience during the crisis have created a powerful mix to attract interest of older generations in sustainable investments, explains Damian Payiatakis, head of sustainable and impact investing, Barclays Private Bank.

“Older generations, who have had to overcome decades worth of being told and shown there is only one way to invest, are increasingly more open to investing sustainably, influenced by younger generations. That is the really distinct shift we have seen over the past few months,” he says.

Sixty-eight per cent of older HNW individuals state that their children have been leading the family on sustainable and responsible investment matters, according to recent research from Barclays Private Bank. As a result, sustainable investing is now resonating with more HNW individuals of all ages and generations, smoothing out recurring conflicts on issues such as different risk appetite. 

“Most of the narrative around sustainable investing focuses on the benefits for your portfolio, alongside people and planet,” explains Mr Payiatakis. “Now we can see its potential benefits for aligning families around shared values, providing a common ground for family discussions around wealth and supporting intergenerational wealth transfer.” 

Substantial increase

The trend towards sustainable and impact investing is catching on rapidly with the private wealth community, according to findings emerging from recent research carried out by Campden Wealth and Barclays Private Bank. Private wealth holders, including HNW individuals, families and family offices are planning to double impact investing allocation by 2025, from 20 per cent to 35 per cent of their portfolios. 

Over the past two years, there has been “a real shift”, with the bank’s behavioural research consistently indicating pent-up demand for sustainable and impact investing. 

“We are starting to see that latent demand being unlocked, and the pandemic has helped accelerate the momentum,” says Mr Payiatakis. The influence of the pandemic is clearly visible in investors’ allocation intentions, with 84 per cent planning to increase their investment to healthcare over the coming year, while 90 per cent of investors say climate change influences their investment choices.

While the investment opportunities most visible in the short term tend to draw investors’ attention, the most appealing ones are those which will ultimately drive structural change, says Mr Payiatakis. “Multi-generation thinking means we want to help our wealthy clients think across decades, and not focusing on this week or month.”

Tracking the flows

Findings from PWM’s fifth annual Global Asset Tracker study (GAT), conducted in January, showed that private banks expect strong growth in client portfolio allocations to sustainable and impact investing over the next three years (see Fig 3). The survey canvassed views of chief investment officers, heads of asset allocation and chief investment strategists at 50 private banks, together managing more than $10tn in client assets globally. 

Client demand, increased evidence that ESG and impact investing generate market rate investment returns, and growing awareness about environmental issues were believed to be the top key growth drivers early this year, supported by broader choice of products and quality managers with scale and track record.

The value of global assets under management applying ESG data to drive investment decisions has almost doubled over the past four years to $40.5tn in 2020, according to research firm Opimas. The figure represents roughly 40 per cent of total AuM worldwide. 

Impact investing, defined as the intention of generating a positive, measurable social and environmental impact alongside a financial return, has also increased rapidly. Showing compound annual growth rate of 17-18 per cent over the past several years, impact investing assets, which are mostly in private markets, reached $715bn, according to the GIIN, the largest global community of impact investors.

Two key trends are shaping the asset management industry, says Amit Bouri, CEO at the GIIN. First, there will be a growing recognition among investment managers that to honour their fiduciary duty, it is essential to consider social and environmental issues. His vision is one of market transformation, where all investments will account for social and environmental impact, and impact investing will help to successfully fill the resourcing gap for the UN sustainability development goals (SDGs).

Second, the unprecedented intergenerational transfer in leadership and management of assets will drive a “huge surge of interest” in impact investing over the next few years. 

“These two trends,” concludes Mr Bouri, “will really shift the expectations of what clients want from their wealth manager.”