Month: August 2020

Understanding the Impact of Volatility on your Portfolio

/ Kiwi Investor / 2 Comments

A key investment concept is volatility drag. Volatility drag provides a framework for considering the trade-off between the “cost” and “benefit” of reducing portfolio volatility.

The volatility of your portfolio matters. Reducing portfolio volatility helps deliver higher compound returns over the longer-term. This leads to a greater accumulation of wealth over time.

When introducing volatility reduction strategies into a Portfolio a cost benefit analysis should be undertaken.

The cost of reducing portfolio volatility cannot be considered in isolation.

The importance of volatility and its impact on an investment portfolio is captured in a recent article by Aberdeen Standard Investment (ASI), The long-term benefits of finding the right hedging strategy.

The ASI article is summarised below.  Access to article via LinkedIn is here.

It is widely accept that avoiding large market losses and reducing portfolio volatility is vital in accumulating wealth and reaching your investment objectives, whether that is attaining a desired standard of living in retirement, an ongoing and uninterrupted endowment, or meeting Pension liabilities.

Understanding Volatility Drag

Volatility Drag is a key concept from the paper: if you lose 50% one year, and make 50% the next, your average return may be zero but you’re still down 25%. This is commonly referred to as the “volatility drag.”

The main disconnect some investors have is they look at returns over a discrete period, such as a year, or the simple average return over two years (zero in the case above).

Instead, investors should focus on the realised compound rate.  The compound annualised return in the above example is -13.97% versus simple average return of zero.

ASI make the following point: “The compound (geometric) rate of return will only equal the arithmetic average rate of return if volatility is zero. As soon as you introduce volatility to the return series, the geometric IRR will start falling, relative to the average return.”

This is a key concept to understand.  Volatility reduces compounded returns over time, therefore it impacts on accumulated wealth.  The focus should be on the actual return investors receive, rather than discrete period returns.  Most investment professionals understand this.

Cashflows, into and out of a Portfolio, also impact on actual returns and therefore accumulated wealth.  This is why a 100% equities portfolio is unlikely to be appropriate for the vast majority of investors. The short comings of a high equity allocations is outlined in one of my previous Posts: Could Buffett be wrong?

Thought Experiment

In the article ASI offers a thought experiment to make their point, a choice between two hypothetical investments:

  1. Investment A, has an average annual return of 1% with 5% volatility.
  2. Investment B, has twice the average return (2%) but with four times the volatility (20%).

An investor with a long term horizon might allocate to the higher expected return investment and not worry about the higher levels of volatility.  The view could be taken because you have a longer term investment horizon more risk can be taken to be rewarded with higher returns.

In the article ASI provides simulated track records of the two investments over 50 years (the graph is well worth looking at).

As would be expected, Investment B with the 20% volatility has a much wider range of possible paths than the lower-volatility Investment A.

What is most interesting “despite having double the average annual return, the more volatile strategy generally underperforms over the long term.”

This is evident in the Table below from the ASI article, based on simulated investment returns:

 Average Annual ReturnStandard Deviation of Annual ReturnsAverage total return after 50 yearsAverage realised internal rate of return (IRR)
A1%5%+53%0.88%
B2%20%-3.0%-0.07%

Note, how the IRR is lower than the average annual return e.g. Investment A, IRR is 0.88% versus average annual return of 1.0%.  As noted above, they are only the same if volatility is zero. 

The performance drag, or “cost”, is due to volatility.

Implications and recognising the importance of volatility

The concept of Volatility Drag provides a framework for considering the trade-off between the “cost” and benefit of reducing portfolio volatility.

The ASI article presents this specifically in relation to the benefits of portfolio hedges, as part of a risk mitigation strategy, and their costs with the following points:

  1. The annual cost can be considered in the context of the potential benefits that come from lowering volatility and more effectively compounding returns.
  2. Putting on exposures with flat or even negative expected returns can still increase your total portfolio return over time if they lower your volatility profile sufficiently.
  3. It is meaningless, therefore, to look at the costs of hedges in isolation.

These points are relevant when considering introducing any volatility reduction strategies into an Investment Portfolio i.e. not just in relation to tail risk hedging. A cost benefit analysis should be undertaken, investment costs cannot be considered in isolation.

As ASI note, investors need to consider the overall portfolio impact of introducing new investment strategies, specifically the impact on the downside volatility of a portfolio is critical.

There are a number of ways of reducing portfolios volatility as outlined below, including the risk mitigation strategies of the ASI article.

Modern Portfolios

The key point is that the volatility of your portfolio matters.  Reducing portfolio volatility helps in delivering better compound returns over the longer-term.

Therefore, exploring ways to reduce portfolio volatility is important.

ASI outline the expectation that volatility is likely to pick up in the years ahead, “especially considering the current extreme settings for fiscal and monetary policy combined with rising geopolitical tensions.”

They also make the following pertinent comment, “Uncertainty and volatility aren’t signals for investors to exit the market, but while they persist, we expect investors will benefit over the medium term from having strategies available to them that can help manage downside volatility.”

ASI also note that investors have access to a wide range of tools and strategies to manage volatility.  This is particularly relevant in relation to the risk mitigation hedging strategies that manage downside volatility and are the focus of the ASI article.

Therefore, a modern day portfolio will implement several strategies and approaches to reduce portfolio volatility, primarily as a means to generate higher compound returns over time. This is evident when looking at industry leading sovereign wealth funds, pension funds, superannuation funds, endowments, and foundations around the world.

Strategies and Approaches to reducing Portfolio Volatility

There are a number of strategies and approaches to reducing portfolio volatility, Kiwi Investor Blog has recently covered the following:

  1. Real Assets offer real diversification: this Post outlines the investment risk and return characteristics of the different types of Real Assets and the diversification benefits they can bring to a Portfolio under different economic scenarios, e.g. inflation, stagflation.  Thus reducing portfolio volatility and enhancing long-term accumulated returns.
  2. Sharemarket Crashes – what works best in minimising loses, market timing or diversification: This Post outlines the rationale for broad portfolio diversification to manage sharp sharemarket declines rather than trying to time markets.  The Post presents the reasoning and portfolio benefits of investing into Alternative Assets.
  3. Is it an outdated Investment Strategy? If so, what should you do? Tail Risk Hedging?: This Post outlines the case for Tail Risk Hedging.  A potential strategy is to maintain a higher allocation to equities and to protect the risk of large losses through implementing a tail risk hedge.
  4. Protecting your portfolio from different market environments – including tail risk hedging debate: This Post compares the approach of broad portfolio diversification and tail risk hedging, highlighting that not one strategy can be effective in all market environments.  Therefore, investors should diversify their diversifiers.
  5. What do investors need in the current environment? – Rethink the ‘40’ in the 60/40 Portfolios?: With extremely low interest rates and the likelihood fixed income will not provide the level of portfolio diversification as experienced historically this Post concludes Investors will need to rethink their fixed income allocations and to think more broadly in diversifying their investment portfolio.

Happy investing.

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

Image from CFA Institute Blog: When does Volatility Equal Risk?

What do Investors need in the current environment? – Rethink the ‘40’ in 60/40 Portfolios?

/ Kiwi Investor / 5 Comments

Investors seeking to generate higher returns are going to have to look for new sources of income, allocate to new asset classes, and potentially take on more risk.

Investing into a broader array of fixed income securities, dividend-paying equities, and alternatives such as real assets and private credit is likely required.

Investors will need to build more diversified portfolios.

These are key conclusions from a recent article written by Tony Rodriquez, of Nuveen, Rethinking the ‘40’ in 60/40 Portfolios, which appeared recently in thinkadvisor.com.

The 60/40 Portfolio being 60% equities and 40% fixed income, the Balanced Portfolio. The ‘40’ is the Balanced Portfolio’s 40% allocation to fixed income.

In my mind, the most value will be added in implementation of investment strategies and manager selection.

In addition, the opportunity for Investment Advisors and Consultants to add value to client investment outcomes over the coming years has probably never been more evident now than in recent history.

The value of good investment advice at this juncture will be invaluable.

Putting It All Together

The thinkadvisor.com article provides the following Table.

Source: Nuveen

This Table is useful in considering potential investment ideas.  Actions taken will depend on the individual’s circumstances, including investment objectives, and risk tolerance.

The Table provides a framework across three dimensions to consider how to tackle the current investment challenge of very low interest rates.

Those dimensions are:

  1. The trade-off between level of income generated and risk tolerance (measured by portfolio volatility), e.g. lower income and reduced equity risk
  2. “How to do it” in meeting the trade-off identified above e.g. increase credit and equity exposures to seek higher income
  3. “Where to find it”, types of investments to implement How to do it e.g. active core fixed income, real assets (e.g. infrastructure and real estate), higher yielding credit assets.

Current Investment Environment

These insights reflect the current investment environment of extremely low interest rates.

More specifically the article starts with the following comments: “For decades, the 40% in the traditional 60/40 portfolio construction model was supposed to provide stable income with reduced volatility. But these days, finding income in the usual areas is as hard for me as a professional investor as it is for our clients.”

Tony calls for action, “With yields at historic lows, we’re forced to choose between accepting lower income or expanding into higher risk asset classes. We need to work together to change the definition of the 40 in the 60/40 split. So what do we do?”

This would be a worthy discussion for Investment Advisers and Consultants to have with their clients.

Returns from fixed income are relatively predictable, unlike equity market returns.  Current fixed income yields are the best predictor of future returns.  With global government bond yields around zero and global investment grade credit providing not much more, a return of greater than 1% p.a. from traditional global bond markets over the next 10 years is unlikely.

Fixed income returns over the next 10 years are highly likely to be below the rate of inflation.  Therefore, the risk of the erosion of purchasing power from fixed income is very high.  This is a portfolio risk that needs to be managed. 

Although forecasted returns from equities are also low compared to history, they are higher than those expected from traditional fixed income markets.

What should Investors do?

The article provides some specific guidance in relation to fixed income investments and a view on the outlook for the global economy.

The key point from the article, in my mind, is that for investors to meet the current investment challenges over the next decade they are going to need a more broadly diversified portfolio than the traditional 60/40 portfolio.

I also think it is going to require greater levels of active management.

This will involve a rethink of the ‘40’ fixed income allocation.  Specifically, the focus will be on generating higher returns and that fixed income is likely to provide less protection to a Balanced Portfolio at times of sharemarket declines than has been experienced historically.

Ultimately, a broader view of the 60/40 Portfolio’s construction will need to be undertaken. 

This is likely to require thinking outside of the fixed income universe and implementing a more robust and truly diversified portfolio.

Implementation will be key, including strategy and manager selection.

There will still be a role for fixed income within a Portfolio, particularly duration.  Depending on individual circumstances, higher yielding securities, emerging market debt, and active management of the entire fixed income universe, including duration, is something to consider.  More of an absolute return focus may need to be contemplated.

Outside of fixed income, thought should be given to thinking broadly in implementing a more robust and truly diversified portfolio. 

Kiwi Investor Blog has highlighted the following areas in previous Posts as a means to diversify a portfolio and address the current investment challenge:

  1. Real Assets offer real diversification: this Post outlines the investment risk and return characteristics of the different types of Real Assets and the diversification benefits they can bring to a Portfolio under different economic scenarios, e.g. inflation, stagflation.
  2. Sharemarket Crashes – what works best in minimising loses, market timing or diversification: This Post outlines the rationale for broad portfolio diversification to manage sharp sharemarket declines rather than trying to time markets.  The Post presents the reasoning and benefits of investing into Alternative Assets.
  3. Is it an outdated Investment Strategy? If so, what should you do? Tail Risk Hedging: This Post outlines the case for Tail Risk Hedging.  A potential strategy is to maintain a higher allocation to equities and to protect the risk of large losses through implementing a tail risk hedge.
  4. Protecting your portfolio from different market environments – including tail risk hedging debate: This Post compares the approach of broad portfolio diversification and tail risk hedging.  Highlighting that that not one strategy can be effective in all market environments.  Therefore, investors should diversify their diversifiers.

There have been a number of articles over recent months calling into question the robustness of the Balanced Portfolio of 60% Equities / 40% Fixed Income going forward.  I have covered this issue in previous Posts, here and here.

Why the Balanced Portfolio is expected to underperform is outlined in this Post.

Lastly, also relevant to the above discussion, please see this Post on preparing Portfolios for higher levels of inflation.

Call to Action

In appealing to Tony’s call for action, there has probably never been a more important time in realising the value of good investment advice and honest conversations of investment objectives and portfolio allocations. 

Perhaps it is time to push against some outdated conventions, seek new investments and asset classes.

The opportunity for Investment Advisors and Consultants to add value to client investment outcomes over the coming years has probably never been more evident now than in recent history.

The value of good investment advice at this juncture will be invaluable.

Addendum

For a perspective on the current market environment this podcast by Goldman Sachs may be of interest.

In the podcast, Goldman Sachs discuss their asset allocation strategy in the current environment, noting both fixed income and equities look expensive, this points to lower returns and higher risks for a Balanced Portfolio.  They anticipate an environment of below average returns and above average volatility.

Happy investing.

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

Is it an outdated Investment Strategy? If so, what should you do? Tail Risk Hedging?

/ Kiwi Investor / 6 Comments

Those saving for retirement face the reality that fixed income may no longer serve as an effective portfolio diversifier and source of meaningful returns.

In future fixed income is unlikely to provide the same level of offset in a portfolio as has transpired historically when the inevitable sharp decline in sharemarkets occur – which tend to happen more often than anticipated.

The expected reduced diversification benefit of fixed income is a growing view among many investment professionals.  In addition, forecast returns from fixed income, and cash, are extremely low.  Both are likely to deliver returns around, if not below, the rate of inflation over the next 5 – 10 years.

Notwithstanding this, there is still a role for fixed income within a portfolio.

However, there is still a very important portfolio construction issue to address.  It is a major challenge for retirement savings portfolios, particularly those portfolios with high allocations to cash and fixed income. 

In effect, this challenge is about exploring alternatives to traditional portfolio diversification, as expressed by the Balanced Portfolio of 60% Equities / 40% Fixed Income. I have covered this issue in previous Posts, here and here.

Outdated Investment Strategy

There are many ways to approach the current challenge, which investment committees, Trustees, and Plan Sponsors world-wide must surely be considering, at the very least analysing and reviewing, and hopefully addressing.

One way to approach this issue, and the focus of this Post, is Tail Risk Hedging. (I comment on other approaches below.)

The case for Tail Risk Hedging is well presented in this opinion piece, Investors Are Clinging to an Outdated Strategy At the Worst Possible Time, which appeared in Institutional Investor.com

The article is written by Ron Lagnado, who is a director at Universa Investments.  Universa Investments is an investment management firm that specialises in risk mitigation e.g. tail risk hedging.

The article makes several interesting observations and lays out the case for Tail Risk Hedging in the context of the underfunding of US Pension Plans.  Albeit, there are other situations in which the consideration of Tail Risk Hedging would also be applicable.

The framework for Equity Tail Risk Hedging, recognises “that management of portfolio risk and equity tail risk, in particular, was the key driver of long-term compound returns.”

By way of positioning, the article argues that a reduction in Portfolio volatility leads to better investment outcomes overtime, as measured by the Compound Annual Growth Return (CAGR).  There is validity to this argument, the reduction in portfolio volatility is paramount to successful investment outcomes over the longer-term.

The traditional Balance Portfolio, 60/40 mix of equities and fixed income, is supposed to mitigate the effects of extreme market volatility and deliver on return expectations.

Nevertheless, it is argued in the article that the Balanced Portfolio “limits portfolio volatility in benign market environments over the short term while making huge sacrifices in long-run performance.”

In other words, “It offers scant protection against tail risk and, at the same time, achieves an under-allocation to riskier assets with higher returns in long periods of economic expansion, such as the past decade.”

The article provides some evidence of this, highlighting that “large allocation to bonds still failed to provide enough protection to add value over the cycle — reducing the CAGR by 170 basis points.” 

Essentially, the argument is made that the Balanced Portfolio has not delivered on its promise historically and is an outdated strategy, particularly considering the current market environment and the outlook for investment returns.

Meeting the Challenge – Tail Risk Hedging

The article calls for the consideration of different approaches to the traditional Balance Portfolio.  Naturally, they call for Tail Risk Hedging.

In effect, the strategy is to maintain a higher allocation to equities and to protect the risk of large losses through implementing a tail risk hedge (protection of large equity loses).

It is argued that this will result in a higher CAGR over the longer term given a higher allocation to equities and without the drag on performance from fixed income.

The Tail Risk Hedge strategy is implemented via an options strategy.

As they note, there is no free lunch with this strategy, an “options strategies trade small losses over extended periods when equities are rising for extremely large gains during the less frequent but devastating drawdowns.”

This is the inverse to some investment strategies, which provide incremental gains over extended periods and then short sharp losses.  There is indeed no free lunch.

My View

The article concludes, “diversification for its own sake is not a strategy for success.”

I would have to disagree.  True portfolio diversification is the closest thing to a free lunch in Portfolio Management. 

However, this does not discount the use of Tail Risk Hedging.

The implementation of any investment strategy needs to be consistent with client’s investment philosophy, objectives, fee budgets, ability to implement, and risk appetite, including the level of comfort with strategies employed. 

Broad portfolio diversification versus Tail Risk Hedging has been an area of hot debate recently.  It is good to take in and consider a wide range of views.

The debate between providing portfolio protection (Tail Risk Hedging vs greater Portfolio Diversification) hit colossal proportions earlier in the year with a twitter spat between Nassim Nicholas Taleb, author of Black Swan and involved in Universa Investments, and Cliff Asness, a pioneer in quant investing and founder of AQR.

I provide a summary of their contrasting perspectives to portfolio protection as outlined in a Bloomberg article in this Post.  There are certainly some important learnings and insights in contrasting their different approaches.

The Post also covered a PIMCO article, Hedging for Different Market Environments.

A key point from the PIMCO article is that not one strategy can be effective in all market environments.  This is an important observation.

Therefore, maintaining an array of diversification strategies is preferred, PIMCO suggest “investors should diversify their diversifiers”.

They provide the following Table, which outlines an array of “Portfolio Protection” strategies.

In Short, and in general, Asness is supportive of correlation based like hedging strategies (Trend and Alternative Risk Premia) and Taleb the Direct Hedging approach.

From the Table above we can see in what type of market environment each “hedging” strategy is Most Effective and Least Effective.

For balance, more on the AQR perspective can be found here.

You could say I have a foot in both camps and are pleased I do not have a twitter account, as I would likely be in the firing line from both Asness and Taleb!

To conclude

I think we can all agree that fixed income is going to be less of a portfolio diversifier in future and produce lower returns in the future relative to the last 10-20 years. 

This is an investment portfolio challenge that must be addressed.

We should also agree that avoiding large market losses is vital in accumulating wealth and reaching your investment objectives, whether that is attaining a desired standard of living in retirement, ongoing and uninterrupted endowment, or meeting future Pension liabilities.

In my mind, staying still is not going to work over the next 5-10 years and the issues raised by the Institutional Investor.com article do need to be addressed. The path taken is likely to be determined by individual circumstances.

Happy investing.

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

Is ESG an Investment Factor? Can ESG be easily harvested?

/ Kiwi Investor / Leave a comment

“ESG is not an equity return factor in the traditional, academic sense”.…… “Nevertheless, ESG can be a very powerful theme in the portfolio management process in the years ahead.” 

These are two key conclusions from a recent Research Affiliates article, Is ESG a Factor?

ESG investing is incorporating Environment, Social and Governance considerations into investment portfolios.

Research Affiliates conclude “that ESG does not need to be a factor for investors to achieve their ESG and performance goals.”

They also call for greater clarity around exactly what ESG is and what it is not. 

“Currently, various stakeholders are sending a whole host of mixed messages. Investors, particularly fiduciaries, need education and alignment. If ESG remains a heterogeneous basket of claims, we will likely never see it fulfill its vast promise.”

Lastly, they believe ESG is likely to be a powerful theme for the new owners of capital, in particular woman and millennials.  Increasingly investors will prioritise ESG in their portfolios in the years ahead.

In my view, it is a stretch to say ESG is an investment factor in the context of Factor Investing.  Nevertheless, the active management of ESG considerations into the investment process has the potential to add value.

You can’t capture the benefits of ESG by just being an ESG investor.  Capturing the benefits from ESG are harder to attain relative to implementing an equity factor strategy such as value or low volatility. 

The risks, and therefore the rewards of ESG, are more company specific.

Therefore, it is not good enough to say one incorporates ESG into the investment management process to gain the benefits from ESG. 

There is no specific ESG factor that can be “harvested” passively.  The ESG value add comes from implementing successfully and having the ability to identify company specific ESG risks. 

What Is a Factor?

Before we can determine if ESG is an investment factor we first need to establish what an investment factor is.

In short, factors are characteristics associated with long-term risk and return outcomes associated with investing into a group of securities. 

The “market”, sharemarkets and fixed income markets are factors themselves (Market Factors).  We know that over time we can expect to generate a return over cash, a premia over cash (premia), from investing in sharemarkets, credit markets (corporate debt), and longer-term fixed income securities (interest rate duration).

Within markets there are also investment factors, which have been shown to deliver a premia (excess return adjusted for risk) over the “market factors” identified above.

The most common of these investment factors, and one receiving a lot of media attention currently, is the value factor.  There are other well know and academically supported factors, including momentum, carry, quality, and low volatility. Investment factors are also known as Premias or Style Premia.

To be considered a robust investment factor, it is generally considered their needs to be support from an economic perspective or there is a behavioural-based explanation for the factor.

For those interested, I have previously Posted on Factor Investing, and this article on Andrew Ang discussing Factor Investment might also be of interest.

Research Affiliates have their own framework on determining the robustness of a Factor, which can be found here.

The Evidence – Is ESG an investment Factor?

To determine if ESG is a factor, Research Affiliates maintain it should satisfy the following three critical requirements, it should be:

  1. grounded in a long and deep academic literature;
  2. robust across definitions; and
  3. robust across geographies.

Academic Literature

The common factors of value, momentum, and low beta have been thoroughly researched and have a track record spanning several decades, as Research Affiliates conclude “very little debate currently exists regarding their robustness.”

In reviewing the academic literature on ESG, Research Affiliates find little agreement on the robust of generating excess returns.  (Their article provides a good source of academic ESG research for those interested.)

In their view ESG is not an equity return factor in the traditional academic sense.

I have posted previously on the Research spanning Responsible Investing, see: Unscrambling the Sustainable Investing Return Puzzle. 

In my mind there is value in undertaking a Responsible Investing approach, including the incorporation of ESG into the investment management process.  This can be the case yet ESG not be a Factor as defined in academia.  The research covered in the above Post provides support for this view.

Factors should be robust across definitions. 

This is an interesting observation.  Research Affiliates argue that “even slight variations in the definition of a factor should still produce similar performance results.”

They use value as an example, using different valuation metrics for value results in similar results over the longer-term.  The value factor is robust across different definitions of value.

Unfortunately, ESG does not have a common definition and is a broad continuum of philosophies, approaches, and strategies.

See a previous Post discussing the continuum of Responsible Investing, which includes ESG: Sustainable Responsible Investing Spectrum

The broad spectrum is highlighted in the following Table presented in the Research Affiliates article to emphasise “ESG has no common standard definition and is a broad term that encapsulates a range of themes and subthemes.” 

As they note, the strategies align more with investor preferences rather than a particular investment factor.  

In the article Research Affiliates present the findings of their research to display how variations in the definition of ESG results in different performance outcomes.

From this analysis, they conclude:

  1. None of the ESG strategies as defined displayed material excess returns;
  2. There was a lack of historical track record, which is a significant impediment to conducting research in ESG investing; and
  3. Only after decades of quality data will it be possible to accurately test the claim that EG is a robust factor.

Research Affiliates also highlight there is an issue with the lack of consistency among ESG rating providers which hinders the ability to determine if ESG is a robust factor.  They provide an example of this in the Article.

With regards to the last requirement, Research Affiliates find that ESG performance results are not robust across regions.

ESG Is Not a Factor, but Could Be a Powerful Theme

“ESG does not need to be a factor for investors to achieve their ESG and performance goals.”

Encouragingly, Research Affiliates see a role for the incorporation of ESG within an investment portfolio. I Agree!

They highlight that there are companies with poor ESG characteristics and that these risks should be incorporated into the stock selection process.

These risks are company specific risks, idiosyncratic risks technically speaking.

Research Affiliates consider carbon as an example, particularly coal.  Notably there has been a move away from coal in the US.  Therefore, “Investment managers who do not consider and integrate the ESG risk of, in this case, climate change may be blindsided.”

The successful implementation of ESG is a key determinant in capturing the value from company specific characteristics.  Specifically, having the ability to identify mispricing of securities due to ESG risk.

It is not good enough to say one incorporates ESG into the investment management process and therefore the portfolios will benefit. 

There is no a specific ESG factor that can be “harvested” passively, the value add comes from implementing successfully and having the ability to identify company specific risks. 

Increasing Adoption of ESG Investing

Lastly, and quickly, Research Affiliates note that there is a “large shift in investor preference toward ESG is occurring as two distinct groups—women and millennials—take greater control of household assets.”  This is backed up by third party research which notes that there will be a wave of assets ready to invest in highly rated ESG companies.

A regulatory push globally is also likely to accelerate this trend.

Happy investing.

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.