Investors are increasingly wanting to feel more involved in how their money is directed towards sustainable investments, and firms will need to cater to this in the not-too-distant future, says Jonathan Wauton, co-founder [and chief commercial officer] of Tiller Technologies.
The rising sophistication of ESG investors is a threat wealth managers can’t ignore.
Few investment trends, if any, have genuinely galvanised a whole generation of investors like ESG (environmental, social and governance) investing has.
Portfolio managers are used to being in a position of power, where knowledge about investments is concerned, but the wholesale embrace of sustainable or ethical investing by their investors means they will, in time, erode this knowledge gap.
Not only do investors know they want ESG-friendly investments in their portfolio, they are also starting to specify what type of ESG holdings they want, identify which managers are leading in the field, and whether they want an active or passive exposure.
This means wealth managers may find it increasingly inappropriate for their clients to be invested in their standardised model portfolios.
There are already a vast array of model portfolios seeking to address a wide variety of investor demands in relation to ESG investing. But the complexity of the trend, and the increasingly bespoke desires of investors, means specialisation will be increasingly sought-after.
For example, different clients will have varying views about how aggressively they want their portfolio to pursue net-zero goals, or to focus on social issues, or broader governance problems. They may also differ in terms of how much ‘impact’ they want their portfolio to have; this being the balance between their desire for their portfolio to provide a financial return versus a social or environmental benefit.
Model portfolios can only go so far here, which means wealth managers need to consider ways to create and monitor bespoke portfolios that can truly address their clients’ sustainability objectives.
One way of doing this could be to re-engineer the core/satellite approach for portfolios, making it relevant for the ESG age.
A clear strategy
Conventionally, wealth managers may have adopted an approach that puts the majority of a client’s cash in more mainstream assets (judged on the basis of performance, irrespective of ESG or non ESG), and then added small pots around this ‘core’ to enable exposure to riskier or more specialist sectors.
This strategy could be evolved for use in offering bespoke ESG portfolios, whereby the core provides exposure to broad climate and ESG-related investments and the so-called ‘satellites’ target the client’s more specific impact requirements, for example.
The beauty of this approach is that the core can also have a tilt, if the client desires, enabling them to truly direct their investments towards the issues and causes they feel most passionate about.
Challenges of data and efficiency
Wealth managers may agree in theory that this vast optionality would be compelling for clients.
But they may have reservations when it comes to considering how a firm could competently manage a myriad of different portfolios in a way that suits the client, keeps regulators happy, and is efficient. For some it may feel like a return to personally managed portfolios, with all the associated problems, which is what the rise of the model portfolio service was supposed to replace.
The problem with choice and flexibility is its effects on other factors, notably volatility and tracking error.
Restricting your universe of investments, which tends to happen the more specialised a theme becomes, often means more concentrated risk. It also often involves straying further from a broad, underlying market capitalisation index, which the portfolio may be benchmarked against.
Thankfully, technological advances are here to help. It is now possible, through the use of specifically developed tools, to create a system where clients can have the portfolio they want, within a systematic process, that can easily be managed & overseen by wealth managers.
Portfolio managers can choose investments from their current buy-lists with pre-attributed ESG scores, to enable them to construct bespoke portfolios for clients that are any shade of ‘green’, while being sympathetic to the client’s risk and return desires.
In this way, technology can be seen as a way of enabling firms to provide clients with new products in new ways, rather than just the same product, more efficiently.
Crucially, such technology allows wealth managers to provide unbiased and transparent data about how ethical or sustainable their underlying investments are too.
Such insight could prove vital when a firm is being questioned by its increasingly knowledgeable clients about the efficacy of their portfolio, or worse still, a regulator keen to find ESG investments that only talk the talk.