Analysis

Where will ESG product demand be in 2024?

Fund selectors reveal the sustainable strategies and asset classes they are looking to add to this year

Biodiversity funds, social themes and a move away from exclusionary funds are all key anticipated portfolio calls for 2024, according to fund selectors.

ESG Clarity asked investment managers where they expect to add exposure from an ESG perspective this year, and where they would like to see more innovation and products coming to market.

As well as repeated nods to nature and the ‘S’ of ESG, fund selectors also flagged the increased diversity in fixed income, moving around the cap-scale and funds that embrace active engagement – as opposed to divestment – as top picks for the year ahead.

We might reduce our weight to exclusionary funds

Jake Moeller, associate director – responsible investment, Square Mile

As we move into 2024, we are looking to potentially reduce gilts and increase UK corporate and global bond exposure. This would allow us to increase exposures to some impact and green bond funds. We are also considering reducing regional equities exposure in favour of broader global equity funds. We like some of the thematic developments in this space such as sustainable energy opportunities and low carbon transition and we might reduce our weight to exclusionary funds.

Looking at the markets, there are some valuation distortions and market leadership concentrations, which favour active fund managers. Much of 2023 was dominated by the returns of the magnificent seven in the US and so a continued broadening of market participation should be a benefit to purer sustainable and impact based funds; which have limited exposure to non-solutions based companies.

Furthermore, we have seen some interesting biodiversity fund launches and funds which are based around sustainable food production and consumption. Paris-Aligned and carbon transition funds are also potentially interesting but some of these strategies are quite complex and require a good understanding of the scenario analysis which underpins them.

SDR will mean momentous changes to the sustainable fund landscape

Louisiana Salge, head of sustainability, EQ Investors

One main priority in 2024 that will influence our fund research is the FCA’s November publication of the final rules on the SDR labels for funds with sustainable objectives. This will be a momentous change for the UK’s sustainable finance space, and we are already working with all our asset managers to ensure their alignment to the label criteria. While EQ’s model portfolios are not yet officially in-scope of the regulation, we expect this to follow soon and are taking a close look at our three sustainable portfolio ranges, disclosures, and data.

In terms of products, we are looking for core-like strategies that meet our sustainable objectives yet present lower biases in terms of style and market cap, providing ballast to the portfolios. For example, a recent addition to the EQ Positive Impact Portfolios is the CT Sustainable Global Equity Income fund, focusing on mature impact solution businesses that provide dividend income, with those exposures preferred by the market in period of uncertainty.

See also: – COP28: Renewable energy commitments are ‘massive tailwind’ for sustainable investments

We are also looking at adaptation. Most climate solution funds focus on companies that present ways to mitigate climate change in its further progress, for example by replacing a reliance on fossil fuel use, but only few explicitly include climate adaptation solutions. Solutions across agriculture, infrastructure and even insurance can present valuable sub-components of the theme

It is also worth noting there are parts of the market that remain difficult for ambitious sustainable and impact investors to access. One of these is the value style – only 10% of sustainable funds have a value focus. We would welcome additional innovative strategies for our portfolios.

 

 

We are looking to integrate more social themes

Patrick Thomas, head of ESG investing, Canaccord Genuity Wealth Management

We are looking to integrate more social themes – such as health and wellbeing, financial inclusion and access to education – into our overall equity exposure. This area tends to be more mid- and large-cap oriented because these are challenging areas for smaller companies to move into, and offers a different sectoral blend to the environmental themes that we have tended to focus on to date.

Market volatility has created a broad opportunity set in environmental and sustainable themes. Some of the most impactful long-term themes tend to have a mid- and small-cap growth focus and this area is cheap vs its historical average and how it compares to broader markets. If we have a macro environment where disinflation and rate cuts are the narrative, some of these themes should be well positioned to deliver in 2024.

Fixed income probably needs more product innovation, although it has improved in the past few years. Strategies here need to start being launched that are more than just standard funds using basic sustainability screens or exclusions. Good examples of what we like here would be recent launches from fund groups like Brown Advisory who have been thoughtful about putting together a strategy that considers both duration risk and real world social and environmental impact.

Adding to global bonds and small-cap exposure

Mark Foster, investment manager, Parmenion

One area we would like to add exposure is high quality global bonds, expanding our current sterling-focus. Proliferation of use-of-proceeds and suitability-linked bonds now offer a wider investable market through numerous regions, while bonds offered by supranational organisations such as the World Bank also bear consideration.

We’re also looking to increase small-cap exposure, where many of the most innovative companies providing solutions to today’s environmental or social problems can be found. And, as the small-cap market appears priced for a deep recession, now could be a favourable time to buy.

While this shouldn’t be new to anyone, this year we’d like to see managers pay greater attention to nature-impact, including biodiversity and deforestation. Aside from the ever-increasing planetary risk itself, the impact of losses from these factors are often not priced into markets, creating broad systemic risks. Helpfully, upcoming TNFD requirements, alongside the Global Biodiversity Framework agreed at COP15 in 2022, should provide a boost in the right direction.

With ESG funds increasingly allocating to the tech space, we’re also looking for greater consideration of ethics in AI, from the purpose of the technology itself and its impact on wider society, to making sure a lack of diversity, or lack of consideration, in the design stage doesn’t lead to inherent biases and discrimination in application.

Renewable trusts and funds embracing active engagement

Darius McDermott, managing director, Chelsea Financial Services

We’re looking at potentially increasing our exposure to climate strategies. Amid a value rotation triggered by inflation and climbing interest rates, climate strategies have taken a beating, and the financial challenges faced by established renewables companies like Orsted and Siemens Energy have soured sentiment further.

However, in the long term, this theme remains resilient, and we see an opportune moment to increase our allocation at a time when valuations look compelling.

We are finding promising opportunities in the renewables trust space. Share prices have been volatile, with many trusts shifting from double-digit premiums to double-digit discounts in less than two years. However, the fundamentals remain strong, with cash flows and dividends steadily increasing.

Biodiversity funds are also an interesting new area. While the potential is promising, we acknowledge the investment case requires further validation, and there is room for strengthening the link between the theme and underlying portfolios. Recognising the complexities, we remain vigilant for compelling opportunities in this space.

I would also like to see more strategies move beyond simple divestment, especially given there is very little evidence this process creates real-world impact. In some cases it may even be harmful, such as when external pressure prompts companies to sell harmful assets to others, like coal.

Funds such as the Redwheel UK Climate Engagement Fund, which embrace active engagement and seek to influence corporate behaviour, are a step in the right direction. I would like to see more impact strategies investing in disruptive change and attempting to alter the status quo rather than funds which simply perpetuate it.

We would like to see more pure biodiversity strategies

Bob Hendriks, chief commercial officer at ABN AMRO Investment Solutions 

We are continuously on the look for new ideas and views. Recently we have done a lot of investigative work into biodiversity funds and social-themed funds. However, in our view the offer is still limited in this space – so we’ll keep monitoring.

We would like to see more asset management companies doing their own bottom-up fundamental ESG research and using material engagement to unlock value for investors. More specifically, from an offering perspective, we would like to see more pure biodiversity strategies. It seems that measurability in this area is still a hurdle, but a hurdle that can be overcome.

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Natalie Kenway

Natalie is editor in chief at MA Financial covering ESG Clarity, Portfolio Adviser and International Adviser. She was previously global head of ESG insight for ESG Clarity and has been an investment journalist...