He says one of the risks to consider is that most companies in the ESG universe are relatively young businesses that are growing quickly, and have enjoyed strong share price performance based on the expectation of future growth.
Such stocks are often called growth shares, and the nebulous nature of many ESG-focused businesses, combined with inflows driving valuations upwards, means clients with a significant exposure to ESG themes risk simultaneously being extensively exposed to growth stocks, even when this might not be the appropriate place for a client to be.
He says avoiding this concentration in any one part of the market probably requires using an active fund.
Paris Jordan, analyst at Waverton, says: “With the introduction of ESG into the suitability questionnaire, every multi-asset specialist should be reviewing their product to ensure it will continue to meet client requirements.
"While the portfolio construction itself may not have to change immediately, the information disseminated to advisers will have to. Advisers will need to understand clearly if a portfolio meets their clients' ESG preferences.”
She adds: “Initially, it is unlikely that all clients will want ESG portfolios and so the shape of existing multi-asset portfolios should not immediately need to change.
"But this will not always be the case as client demand for ESG is set to increase further – due to environmental awareness, demographics and the intergenerational wealth transfer.
"Longer term, multi-asset managers will have to consider this increase in demand and begin to shape their portfolio construction to cater for this. Managers will have to consider ESG criteria of individual investments and of the portfolio as a whole.
"If done well, this will take time and so, in the near future, it is important to recognise what is most pressing: delivering high quality and easily digestible ESG portfolio information so advisers can meet their regulatory requirements.”
Long-term obligations
Nick Watson, multi-asset investor at Janus Henderson says rules that are about to be introduced will mean all multi-asset portfolios will be obliged to consider ESG factors.
He says: “Portfolio construction of the multi-asset strategies is going to evolve as new sustainability requirements come into force. With the EU Action Plan’s Sustainable Finance Disclosure Regulation (SFDR) being effective from March this year, investors will have a much better insight into a sustainability framework that a portfolio complies with, and choosing investments in line with their sustainability preferences should prove more straightforward.
"Constructing multi-asset portfolios in a sustainable manner in line with the stricter SFDR Article 9 for example, will mean portfolio managers would need to optimise risk-adjusted return outcomes in parallel to achieving sustainability objectives such as carbon exposure reduction, lowering carbon transition risk or supporting better diversity and inclusion practices.
