The emergence of environmental, social and governance (ESG) investing, and the principles it entails, has increased the demand on investors to adopt a more active investment strategy, say leading experts.
Where once maximising financial return was the only investment mantra, the situation today calls for responsible and impact investing to be set as targets alongside profits, a senior executive of a Malaysia-based asset owner institution told AsianInvestor.
However, other leading experts say that a mix of both passive and active investment strategies is best during the current period of volatility.
ENGAGEMENT TRUMPS SCORES FOR ESG INVESTING
“If you were to fast forward to where we are today, there’s a lot more understanding, a lot more push and a lot more interest in this space,” he said on condition of anonymity.
He added that with investors putting more focus on achieving ESG targets, the need for them to be more engaged with their assets and portfolio managers had also become more pressing.
“I think there is a need for active investing in the space because there is a need for asset owners and the investing fraternity, in general, to say I’m not only interested in maximising profits, I’m also interested in maximising sustainability,” he said.
Given that ESG scores and principles are relatively new in Asia, he said institutional investors must engage actively with their investee companies and intermediaries to acquire a contextual understanding, going beyond the prescribed formulas put to them by portfolio managers and rating agencies.
He cited palm oil producers, often associated with negative perceptions of non-ESG compliance, as an example of an industry where it pays investors to engage directly with the producers to understand the issues rather than making the decision based purely on ESG scores.
Northern Trust’s Krishan Dave, who heads its investment risk and analytical services, told AsianInvestor that the push to become more ESG-focused had led to a more active approach among some investors almost to the point of becoming overly restrictive in some cases.
“We have seen examples of asset owners changing clauses and adding extra requirements in the investment guidelines they have with their investment managers,” he said.
Such guidelines are usually contained in the investment mandate and include parameters such as country and currency exposures, market and exchange restrictions, and minimum and maximum thresholds for asset class exposures.
“It can be argued this is a more active approach with respect to ESG investing, but it can also simply be construed as a narrowing of the type of investments an investment manager can make,” he said.
He said there are asset owners who adopt a “light-touch” approach which, while it requires fund managers to beat ESG benchmarks, does not impose on them a high ESG score-only framework.
MARKET VOLATILITY REQUIRES A STRATEGY MIX
There is a view among the experts that a combination of active and passive investing is required when markets are volatile.
“We recommend investors always allocate to both passive and active strategies. The weight of passive is typically increased at times of uncertainty, particularly by reducing exposure to high-conviction strategies focused on growth themes,” Maxime Perrin, head of sustainable investment at Lombard Odier Investment Managers told AsianInvestor.
He said the risk of passive investing is usually the absence of personalisation and alpha, while active investing can spring nasty surprises as the portfolio are typically very concentrated.
Capital Group’s investment director Andy Budden advocates taking the long view.
“Our advice when it comes to navigating volatile markets is to focus on smart investing – keep a long-term investment horizon and focus on relevant research, solid data and proven strategies,” he said, adding that time is often required for well-researched, high-conviction investments to perform well.
RISK PROFILE – A KEY DETERMINANT
There is consensus that the choice between active and passive investing ultimately depends on the investor’s risk appetite and maturity.
“The first driver is every asset owner has their own risk profile. They've got different objectives. They know how much risk they can possibly absorb,” said Northern Trust’s Dave.
With that understanding, an investor will be able to allocate funds to portfolios of different risk levels that require varying degrees of attention.
The more established investors are also better equipped, in terms of experience and data sets, to employ an active investing strategy.
Lombard’s Perrin said: “We are convinced that a healthy portfolio needs both to reflect the client’s preferences and risk/return targets.”
Note: The article has been amended to reflect Krishan Dave's name accurately.