“Disruptive forces have accelerated secular transformation, which brings thematic investments to the fore,” said Jason Yu, head of multi-asset management, Asia at Schroders.

Just like any single asset class, thematic multi-asset strategies can also experience divergence in return over shorter periods. This is to be expected; themes are long-term in nature and a wide range of factors – from macro policy and valuations, to style and sentiment – can create variations in short-term performance.

Taking climate change as an example, it is a broad scope that covers an array of sub-themes from decarbonisation, electric vehicles, zero-emission aircrafts to energy alternatives.

“This is why a diversified approach with active, dynamic asset allocation is warranted for a smoother path of returns from sustainable investing,” said Yu.

This is particularly important for investors as they seek exposure to the drive to decarbonise. This cuts across multiple sectors and regions, with climate change initiatives and the transition from fossil fuels to clean energy requiring vast investments – as outlined in a recent report by the International Energy Agency (IEA), “Net Zero by 2050: A Roadmap for the Global Energy Sector”1.

“With a multi-asset approach, investors can dynamically access opportunities in equities and fixed income from renewables and alternative energy sources, to meat substitutes and electric vehicles, and all the relevant supply chains involved,” explained Yu.

Managing multiple factors through an ESG lens

Bottom-up security selection is a key part of multi-asset investing. Yet being able to marry the objectives of diversification and long-term risk-adjusted returns against the backdrop of sustainability requires deeper insights over as long a timeframe as possible.

To get a picture of which considerations to factor into investment decisions, Schroders decided in 2020 to start incorporating the impact of climate change into its 30-year asset class return forecast.

The process involves estimating the implications of climate change via several factors. Among these, for example, is the potential effect on productivity in different countries of various rises in temperature.

“We have seen some really insightful results so far,” explained Yu. “In general, when temperatures rise in tropical countries that are closer to the equator, the environment becomes less bearable, and productivity and lifestyles would suffer. On the other hand, in countries further north from the equator, such as the UK, Canada for example, there are benefits to productivity from the same degree of warming. Certainly, this is only one way to look at investing from a climate change standpoint.”

In short, this creates greater awareness and provokes thoughts about when to invest into a certain country or sector, and about the impact on the ESG score.

This aligns with Schroders’ approach to fully integrate ESG in multi-asset strategies (a process completed in 2020), with sustainability as one of the four key pillars that underpin the team’s philosophy in generating sustainable returns and mitigating risk.


Schroders’ multi-asset ESG approach

Budgeting for sustainability

To further enable multi-asset strategies to reflect and integrate ESG factors more accurately and effectively, the Schroders “sustainability budget” measures the percentage of the capital allocation in the portfolio which integrates ESG factors, or that is managed with a sustainable approach.

“It can be seen as a risk budget in terms of ESG considerations,” said Yu.

This has trade-offs. A key one is the need to remove or reduce exposure to asset classes and company components not deemed sustainable from the universe available for investment.

However, said Yu, the benefits from the resultant flexibility are compelling. “It provides the investment team with a flexible tool to monitor and measure the sustainability degree of the portfolio, while permitting other assets that are useful for diversification, tactical asset allocation and risk reduction.”

This also leverages the firm’s proprietary tools such as the CONTEXT framework and Schroders SustainEx. They are embedded within research and asset allocation, to understand implications for risk premia across asset classes and to flag sustainability risks.

“These tools quantify ESG impacts objectively and are essential in helping us implement the sustainability budget,” added Yu.

Putting multi-asset strategies in the mix

While the pandemic has accelerated awareness on sustainability, it has also polarised opinions on the potential for sustainable investing.

As investors increasingly focus on questions around performance of ESG-related opportunities versus their traditional holdings, considerations include the sustainability universe, investment objectives, climate implications, and more.

“What we do is to make sure we dynamically allocate,” said Yu. He raised a few MSCI indices as examples, where MSCI USA ESG Leaders underperformed MSCI USA which in turn underperformed MSCI USA Climate Change (see table below). This highlights that inconsistencies exist in performance measurement and proves that there are nuances that investors need to consider.


ESG indices have a low correlation with each other

Ultimately, multi-asset strategies offer something a single asset class cannot. “It is essential to apply tactical thinking based on short-term performance and volatility to benefit from the widest opportunity set, while also benefitting society and the environment over the long run,” said Yu.

Click here to learn more about how Schroders views sustainability and makes an impact through sustainable investing.
 

Sources
1 - 
https://www.iea.org/reports/net-zero-by-2050

IMPORTANT INFORMATION
Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.