As sustainable equity funds have evolved over the years, with the industry becoming larger and more mature, so too has their role in a portfolio.
But that role is not set in stone.
Alex Matcham, head of wholesale distribution at M&G, notes the role of sustainable funds in a portfolio varies, depending on the investment approach.
Matcham says: “Some advisers/wealth managers have exclusively sustainable/ethical portfolio offerings, in which case the challenge can be getting a diversified style exposure across portfolios.
“Within broader portfolios, clients are increasingly seeing the opportunity to add further diversification into their portfolios by including more sustainable strategies alongside funds with no explicit sustainability characteristics.”
In the past, there was more of an emphasis on exclusions and negative screening in sustainable funds.
Claudia Quiroz, head of sustainable investment at Quilter Cheviot and manager of the Climate Assets fund range, says this is clearly still very important for a portfolio that wants to invest sustainably, as high environmental impact sectors, such as fossil fuels and mining companies, are likely to be avoided.
However, what she is seeing now is a focus towards inclusions and positive criteria; investment strategies focusing on exposure to companies that are trying to find genuine solutions to environmental or social issues like the climate crisis.
These are likely to be companies operating in growing sectors supported by regulation and consumer demand and thus the opportunity set is "much more robust".
Quiroz says: “Sustainability funds can offer strong diversification to a traditional portfolio focusing on the old resource-intensive economy.
“Sustainable funds will likely have a growth company bias and be on the mid-cap side of the market and thus can also provide a good balance to more large/mega-cap-focused funds that are perhaps more benchmark aligned.
“As a result, sustainable funds will likely have a higher active share – the difference between a portfolio's holdings and its benchmark index – and thus potential for outperformance by stock selection.”
In a high interest rate environment sustainable funds have struggled – 2022 a case in point – but there are hopes of a likely rate cut in the near months.
Quiroz says it is also important to assess the economic backdrop of today.
She adds: “We are in a high interest rate environment, but with central banks likely to start cutting rates soon, it is an environment where both equities and bonds can generate returns.
“As such, sustainable equity funds work well in a multi-asset portfolio with a focus on growing markets like renewable energy, electric vehicles, cybersecurity and automation and robotics.
“The sustainable bond market remains nascent, so it is perhaps more straightforward to gain exposure to sustainable companies via equity investments, while maintaining overall diversification of the portfolio.”
