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Climate change – time to consider a multi-asset investment strategy?

Today, half of the articles in investment magazines seem to be about ESG and climate. In our experience, very few funds are actually designed with a clear climate goal.

With China now aiming to be carbon neutral by 2060 and companies making rapid progress in alternative energy technologies, we are on the cusp of a revolution. We expect to see a massive shift in the way we live and work. Forecasts suggest around a 20-fold growth in revenues for electric vehicles and renewable energy by 2050. This will be accompanied by enormous improvements in range, charging speed, availability and cost. Meanwhile, businesses are developing new technologies that will remove carbon from the air.

There are many investment solutions that seek to capitalise on the climate opportunity. Among them, we believe a multi-asset approach is particularly compelling. Here, asset managers can offer investors a focused exposure to the climate theme, while seeking to carefully manage the risks that sometimes come with higher return potential.

The first challenge for investors is how to access the climate theme. It can be surprisingly hard to find investment funds with strong exposure to the technologies that will drive the low-carbon transition. These technologies include renewable energy generation and equipment, electric vehicles, battery technologies, energy efficiency and renewable heat.

This is counterintuitive, given the dozens of sustainability funds that investment houses launched in the last few years. But if you take a look at the top-10 holdings in many funds with ‘climate’ or ‘sustainable’ in the label, you will frequently find mainstream names like Microsoft or Amazon. These companies may have good operational environmental policies, but they are not strongly exposed to the climate opportunities theme. Their earnings come from software services and online retail, not renewable energy or battery technologies. Why, then, are they in the portfolio? We suspect it is because most sustainability or climate funds have standard equity benchmarks and tight tracking-error limits that require them to hold benchmark-like exposures.

This is one reason why European regulators are concerned that funds labelled ‘sustainable’ and ‘climate’ might be confusing to customers. Enter the European Union’s new Sustainable Finance Disclosure Regulation. It requires funds with sustainability investment objectives to report their exposure to objectively defined sustainable business activities (the EU Taxonomy). Our initial analysis suggests that standard global equity benchmarks only have a 5-10% exposure to EU Taxonomy-aligned activities. We find that many funds that are labelled ‘sustainable’ do better than this, doubling the level of exposure to 20%. However, this still leaves 80% of funds exposed to activities that are not strongly associated with the sustainability theme.

One solution is to forgo standard equity benchmarks and instead start with a list of companies whose core businesses provide climate solutions. This means investors can potentially align around 75% of their portfolio with the EU Taxonomy, rather than a mere 20%. This means, though, that such a fund will perform differently to standard equity benchmarks. However, we believe that if an investor is serious about gaining strong exposure to the climate theme, then the portfolio has to look different to a benchmark that is only 5% exposed to this theme.

How can we achieve a smoother investment journey? We believe diversification provides the answer. And one way is through a multi-asset approach that seeks to ensure diversification at two levels: through equities and across asset classes. Within equities, investors can have broad exposure across the full range of companies exposed to the climate theme. Investors can also diversify across asset classes.

As technologies develop, we have the chance to make sure our children inherit a more sustainable world. The route to this change will come in part through the investments and the choices we make. One way is by investing in companies that are engaged in activities that seek to help the world mitigate, or adapt to, climate change. In doing so, investors can play their part to try and ensure that climate change is not inevitable. But the clock is ticking.


Notes

These figures relate to simulated past performance. The simulation was performed using a model portfolio of equity, credit and infrastructure securities with high EU Taxonomy alignment. When interpreting the results, the investor should always take into consideration the limitation of the model applied. The returns are shown before fees and other charges. The impact of any charges will reduce the performance shown. Figures are shown in GBP. Source: adrdn, Bloomberg, MSCI, S&P. August 2021.

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested. Issued by abrdn Investment Management Limited which is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL and authorised and regulated by the Financial Conduct Authority in the UK


About the authors

Craig Mackenzie, Head of SAA Research, Aberdeen Standard Investments

Craig is responsible for developing and ensuring holistic application of ESG factors into the Multi-Asset Strategies processes, and supporting the continued development of ESG products. He previously led the Strategic Asset Allocation (SAA) team and was responsible for the firm’s advice to clients on long-term investment returns and strategy. Craig has been leading on SAA research since 2015.

Prior to this, Craig’s work focused on ESG issues: from 1997-2010 he created and led the ESG functions at Friends, Ivory & Sime and at Insight Investment, and the Centre for Business and Climate Change at Edinburgh University. Craig also has a PhD in behavioural finance and remains a senior lecturer at Edinburgh University Business School.

Justin Simler, Head of Multi-Asset Product Strategy and Investment Specialists, abrdn

Justin previously worked for Tatton Investment Management and prior to that was Head of Product for Multi-Asset at Ninety One Asset Management. Before this he was Global Head of Product Management for Multi Asset and Head of Product Management for Quantitative Equity Products at Schroders.

He started at BZW (the investment banking arm of Barclays) on the graduate programme and worked as a fund manager on UK smaller companies and in Paris before moving to Bangkok as CIO for Thai Asia Mutual Funds and Head of Research for BZW KTT. He worked for Barclays Wealth in London as Head of Global and International Fund Management.


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