Building a sustainable portfolio in uncertain times

EMBRACING a greener and more sustainable future has been a topic globally for decades and the attention on such issues has clearly accelerated in recent years.

With the Covid-19 pandemic and recent geopolitical tensions worsening issues on healthcare, supply chain disruptions and energy shortages - on top of the effect of climate change, biodiversity loss and social unrest - the focus on sustainable solutions that provide long-term stability has become even more important in the global economy.

The adoption of sustainable practices is increasingly being driven by market forces alongside legislation, with capital from investors working to nudge businesses down a more sustainable path.

The rigorous integration of sustainability factors into investment processes allows for a more complete analysis of an investment, said experts from Citi Global Wealth, of which Citi Private Bank is a part of.

Having a holistic view of operational and regulatory risks, business strategy, management quality, and competitive positioning enables savvy investors to uncover hidden risk and opportunities, while deploying their funds in a purposeful manner.

"Sustainable investing is a collective descriptor for a range of investment approaches that can help investors meet both financial and sustainability objectives," said Harlin Singh, global head of sustainable investing at Citi Global Wealth.

BT in your inbox

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign Up

Sign Up

"The motivations for investors to make sustainable investments are very broad and varied," she added.

"Some investors may seek to mitigate investment risks associated with environmental, social and governance (ESG) issues, while others may hope to gain exposure to innovations that capitalise on secular growth. There are also those who want their investments to align with their personal values and/or philanthropic activities."

Sustainable investment allocation

Throughout the last few years, Citi Private Bank - which serves ultra-high-net-worth individuals and family office - has seen investors who consider ESG risks and opportunities in their investments focus on all three 'E', 'S' and 'G' factors.

"Many investors have long favoured investment strategies focused on environmental issues both from a risk and opportunity perspective," said Janet Shum, sustainable investing specialist for Asia Pacific at Citi Global Wealth.

"Risks including the effects of climate change and biodiversity loss on financial and operational performance of companies have been observed by investors," she said.

"Meanwhile, the commitments to achieve net-zero made by many countries and companies have accelerated the demand and growth of sustainable solutions and technological advancement in this field. A systemic net-zero transition could increase the global economy by US$43 trillion in net present value terms from 2021- 2070 according to Deloitte's Global Turning Point Report 2022."

Environmental investment strategies are also more established in terms of product variety, track record and regulatory scrutiny.

Many investors are also looking beyond environmental factors.

"The interest in the social aspect of sustainable investing has grown, partly driven by the impact of the pandemic, and social movements around race and gender", Shum said. "Areas that are especially of interest include investments relating to healthcare, diversity and inclusion, and cyber security."

"Similarly, good governance is viewed as a critical foundation for companies to achieve their environmental, social, and financial goals, with companies' board and management facing growing scrutiny from stakeholders."

Shum said: "With the realisation of the interconnectedness of 'E', 'S' and 'G' and the benefit of diversification, there is increasing investor interest in multi-thematic strategies and the concept of building a portfolio that is diversified across impact areas."

Different investments incorporate sustainability criteria in different ways, allowing investors to achieve varying financial outcomes, depending on the asset class selected and their investment objectives.

Some, for example, may choose an exclusionary approach to avoid allocating assets into companies such as fossil fuel producers or defense providers. This could result in greater volatility compared to a conventional benchmark as there are constraints to the investment universe.

Other investors may adopt a thematic or impact investing approach to gain exposure to megatrends and innovations that address pressing environmental and social issues.

Increasingly, investors are looking to build out a core portfolio that integrates ESG risk considerations, with additional opportunistic or satellite portfolios that may target more bespoke sustainability goals to generate additional returns.

Shum said: "Investors should evaluate the investment solutions with multiple lens and consider other investment criteria and managers' qualities on top of the sustainability attributes that could affect the financial performance."

Financial outcomes

The top misperception of sustainable investments is the financial performance trade-offs, Citi experts observed.

"Numerous studies have given an overriding conclusion that sustainable investments can offer similar competitive risk-adjusted returns as conventional investments," Singh said.

Citi Private Bank's Office of the Chief Investment Strategist did an analysis using Morningstar data on over 500 US equity funds between Jan 2010 to Dec 2020 and found that strong ESG attributes enhance a portfolio's long-term risk-adjusted performance with a higher Sharpe ratio and lower average volatility.

While investments could still be affected by short-term volatility, Citi experts emphasised that long-term results are what investors should focus on.

Market conditions, including the higher interest rate environment in the first half of 2022 saw many quality public companies decline in valuation. The deratingacross growth companies included some strong companies in sustainability themes.

However, the changing economic environment has not changed Citi's views on the accelerating long-term relevance and importance of the unstoppable trend of greening the world.

"Market volatility has created opportunities to invest in fundamentally attractive businesses whose long-term growth opportunities are aligned with the UN's Sustainable Development Goals," Singh said, noting there is strong demand for novel technologies and business solutions to address pressing environmental and social issues.

Investors would be able to seek out opportunities in the value chain for renewable energy including solar, wind, hydrogen, energy storage and infrastructure. Apart from companies involved in energy transition, there are also potential opportunities in diverse areas such as sustainable agriculture, food production, and water. Hard-to-abate sectors, such as steel and cement, are also starting to see some innovation.

"There is no one route to sustainable investing. We see a variation of degree to which investors wish to achieve their financial goals and sustainability objectives," Singh said, noting that this is a journey for investors to take to transit their portfolio towards sustainable investing.

"In some cases, sustainable investments comprise a small part of an investor's overall portfolio. But increasingly we see investors seeking to apply a sustainability lens to their full set of investments."

Brought to you by

Citi Private Bank 8 Marina View, Asia Tower 1, #20-01 Singapore 018960 Tel: +65 6227 9188 Website: www.citiprivatebank.com