ESG analysis can be integrated into multi-asset investing strategies using both top down ethical screens and bottom-up ESG signal integration to construct portfolios covering commodities, credit as well as equities, according to First Sentier Investors.
First Sentier Investors integrates responsible investment strategies and tools in the way the Multi-Asset Solutions (MAS) team manages its portfolio. The multi-asset strategy portfolio currently has $220 million in assets under management.
By building up a bottom-up multi-asset strategy based on internal team management, First Sentier says the resulting strategy is both lower cost and allows for integration of an ESG strategy that is consistent from both a top down and bottom-up perspective, said Kejal Somaia, co-head of Multi-Asset Solutions.
"By building bottom up, we remove those costs, and by using futures, long and short, you can bring the frictional cost down from 20 to one bsais point," Somaia said. "Then you have the opportunity to add value through various decisions in the portfolio. The genesis of that is around implementation and flexibility, but the by-product is that by building from the bottom up ,we get flexibility around ESG integration."
The multi-asset strategy began applying negative screens in 2017, and within each theme, the fund excludes tobacco, controversial weapons, fossil fuels, GMO plants and seeds, gambling, companies that receive more than 5% of revenue from the sale of alcoholic beverages, adult entertainment, animal welfare, and nuclear power production. As of 2020, the combination of those screens could remov e between 30% and 55% of companies in major indices, First Sentier notes.
"We moved from negative screens because we now hold securities directly rather than outsourcing to other managers, so we have proxy voting," Somaia said. "We use the services of Glass Lewis as advisers for proxy voting, and we moved to the ESG policy in late 2019 and early 2020. We benefitted from conversations we had with other investment teams and this is where we got to."
The integration of First Sentier's responsible investment policy happens through both negative screening and engagement with companies within the portfolio, said Heath Palos, portfolio manager.
"We can do it on a theme-by-theme basis, where sometimes the ethical screen is the better tool," Palos said. "Engaging with Exxon Mobil doesn't make sense. But if we're talking modern slavery and encouraging companies to look to their supply chain, that does make sense in engagement."
The engagement approach can also differ by asset class, whether it be through equity holdings or credit holdings, Palos noted.
The conversations that the team have with management in listed companies tend to be the same type of conversations that other teams have, and we can influence in different ways," Palos said. "Whereas credit, in my experience, they can engage, but there a bit more like passengers. But of course, they have certain powers in engaging, and both have the power to increase access to management."
The multi-asset strategy also shorts as part of its operations, and can short based on ESG considerations. First Sentier said that shorting is used to manage risk and in their portfolio is a driver of return, and uses short derivatives such as index futures, index options, interest rate swaps and currency forwards. First Sentier argued that shorting can also increase the cost of capital for a company and is "almost akin to a 'no' vote rather than just not voting for something," and works "on the same principle as the theory of divestment," said Palos.
Currently, the team is debating whether they apply shorting to commodities such as fossil fuels on ESG grounds.
"One of the challenges we have is that although we have this clear purpose on commodities, when it comes to putting in a shorting strategies on commodities like crude oil and heating oil, we are now having a bit of a debate about if we're excluding a lot of the sub industries in the sector from an equities perspective, does it make sense to hold on to those allocations within the commodities space," Somaia said. "It is a challenging convo, and it's something we have to work through. We can't exclude energy completely, but can we allow shorting?"