Michael Blayney: ESG is now a critical factor in asset allocation

Environmental, Social and Governance factors are now critical in asset allocation decision-making says Pendal’s Head of Multi-Asset Michael Blayney.

 
THE BIGGEST secular shift over the next decade is arguably the continuing emergence of — and demand for — Environmental, Social and Governance (ESG) factors in investment portfolios.

In the past ESG may have been considered, but it seldom had a meaningful value ascribed to its risk and wasn’t thought of in terms of asset allocation.

But ESG has emerged as a secular theme, alongside demographics, debt levels and productivity — and investors must think more deeply about how it fits into a portfolio.

“In the past, when an investor put together an ESG-focused portfolio, it would basically have the same asset allocation as a conventional fund,” says Michael Blayney, who head up Pendal’s multi-asset investment team.

“Now it’s essential to think about how we can incorporate ESG and sustainability factors into both strategic and active asset allocation decisions.”

Critical big-picture factor

ESG has not only emerged as a long-term secular consideration, it’s becoming the most critical “big picture” factor for the next decade.

“The time between a scandal breaking out and a CEO being shown the door has shortened considerably,” says Blayney. “Community expectations have shifted, particularly on the environmental side.”

“We’re seeing it in Europe with the new Green Deal. With the change in the White House, the US economy will shift that way too. There’s clearly a long-term thematic going on. People are focused on how they can contribute to – and benefit from — long-term, positive solutions.”

Of the different ESG factors, the environment provides one of the clearest links to economic growth factors.

“If you take Australia, we actually look a lot worse on environmental performance because we dig a lot of fossil fuels out of the ground and still use a lot of coal for our energy,” Blayney says.

Because the Australian economy and market is more exposed to environmental issues, it creates a secular headwind. About three quarters of Australia’s energy mix is from coal and we are the world’s third biggest fossil fuel exporter according to recent research by the Australia Institute.

“As a result, the home bias in asset allocation should be reduced from historical levels and more so for sustainable funds,” Blayney says. “The Australian economy scores very well on the S and G factors of ESG, but the equity market is let down by our high carbon intensity.”

Governance and social issues matter as well, and are particularly critical considerations in emerging markets.

“There have been studies that show well-governed businesses tend to perform better,” Blayney says. “But there are nuances in that. The rate of change of governance can be very important too.

“We’ve invested in Korean and Japanese equities at times in the last couple of years and a key element of the investment thesis has been improved governance in those countries.”

Opportunity for better returns

ESG is moving beyond risk management. “Previously investors tended to focus on the bad stuff, and how that could trigger a fall in a share price,” Blayney says.

“It’s obviously still important … but nowadays we also think about ESG and sustainability in terms of the opportunity to generate better returns from the portfolio.

“It’s very much a big shift in thinking and it’s coming into the mainstream. But it has evolved more in some markets around the world, notably Europe. There’s a bit of ground to make up in the United States, Australia and parts of Asia. That provides opportunity,” Blayney says.

“When you consider how some big investors allocate their assets, there’s still quite a lot more that can be done to better align with both ESG risks and opportunities. Many investors know about ESG, but they’re not sure if it’s already factored into the price [of an asset]. That’s where we can help.”

There’s a pressing need for investors to consider ESG factors when allocating assets.

“In our research, the integration of ESG risks added weight to decisions to decrease exposure to Australian shares,” he says. “It also indicated investors should increase weightings to some offshore opportunities.”

“While a lot of environmentally aligned assets have had a strong run, we still think there’s good opportunity in the longer term.”

About Michael Blayney and Pendal’s Multi-Asset capabilities

Michael Blayney leads Pendal’s multi-asset team.

Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

The team — which includes Stuart Eliot, Allan Polley and Rita Fung — manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.

Find out more about Pendal’s multi asset funds here

Contact a Pendal key account manager here