We've heard the theory so how does sustainable investment work in practice and live up to the billing? The world's largest wealth manager gives some pointers.

As part of our series looking at environmental, social and governance-themed (ESG) investment, here are thoughts from James Purcell, head of sustainable and impact investments at UBS Wealth Management, part of UBS. This news service is running series of articles in May about ESG, both in terms of its advantages and potential problems. See an editorial analysis here. This publication is pleased to share these views; it does not necessarily endorse all views of guest contributors and invites responses. Email the editor at tom.burroughes@wealthbriefing.com

Making sustainable investing work in practice for investors, not just in theory

Whether you are speaking with your financial advisor, reading a newspaper, or even sitting on public transport, the chances are you will have been bombarded by sustainable and impact investing products and adverts.

The result for people working in the financial services industry is a lot of curious questions when meeting with high net worth individuals: What is sustainable investing? Should it be part of my portfolio? Do I have to give up returns? What impact can I have? How can we be sure? 

Undoubtedly, there is now a broader understanding and a growing consensus among investors and wealth managers alike that investing sustainably is a worthwhile endeavour. However, the challenge facing the financial services sector is now making sure that it works in practice, not just in theory.

All about equities?
One particularly ingrained perception among investors is that sustainable portfolios place a heavy emphasis on equities, which may deter investors who favour a more diverse portfolio.

However, other sustainable asset classes are beginning to evolve extremely quickly and are becoming popular non-equity options. In particular, fixed income is an area with a lot of potential.

In the equity world, sustainability is often used as a "lens" to identify certain characteristics of a stock, and with that lens try to generate outperformance. Just as Warren Buffet uses a "value" lens and hunts for companies he believes are "cheap", a sustainable investor can use an "ESG best-in-class lens" to search for companies that manage the risks and opportunities presented by environment, social, and governance (ESG) factors in a superior way to their peers.

On the fixed income side, different opportunities are emerging, and there are dedicated assets which in and of themselves are inherently sustainable. Examples of this include green bonds or development bank debt – where all the proceeds of the bond go to sustainable projects. 

As an example, UBS has been working alongside the World Bank and Solactive to create a family of multilateral development bank bond indexes. These indexes track the performance of bonds issued by development banks, enabling wider groups of investors to allocate funds to this sustainable high-quality fixed income alternative. This in turn can broaden awareness of sustainable investment solutions.

Personalisation
Another key issue for sustainable investments is that of personalisation. Parts of the financial services sector have yet to fully tailor philosophies and content sufficiently to match clients’ personal interests.

Typically, investors are given generic ESG information on which to base their decisions, companies are labelled either "sustainable" or "not sustainable", often on opaque methodologies. Such an approach fails to account for clients’ sustainability affinities and can lead to them disengaging with sustainable investing.

To help address this challenge, UBS has piloted a holistic portfolio approach that scores over 10,000 companies across seven dimensions including water, climate change, and ethics. Clients can thus express their own identities in their portfolios and, by weighting their affinity to each of the seven topics, can be assured that the resultant sustainability recommendation fits with their personal values and interests. 

Understanding impact and affecting change
Our recent Investor Watch survey of over 5,000 high net worth clients showed that one of the primary reasons for investors not embracing sustainable investing is that they are unable to understand the impact that their investments are making. 

Even among the 61 per cent of investors who said that they do invest sustainably, 72 per cent said measuring impact was difficult.

The most common concern I hear is that investors justifiably question whether divesting a company’s stock from their portfolio would have significant impact and prompt that company to change its objectionable practices.

The latest research suggests that excluding companies has little impact on company behaviour, for the shares are, by definition, bought by another (perhaps less socially conscious) investor. For investors seeking to have positive impact in public markets, we recommended pursuing a policy of active engagement and using one’s voice as a shareholder to encourage positive change. Such policies though are not always easy to do, hence why many in the industry are seeking simpler exclusions. However, done with expert partners and at scale the effects of engagement can be tremendously effective. 

Many investors now believe in applying their values through sustainable investing to help shape the future. However, the financial services industry must meet this demand by offering a more diverse set of assets, such as fixed income, and by offering investments which are aligned to their personal values. 

Above all though, clients require transparency and honesty with regards to these investments and their impact. With this level of openness, investing sustainably will continue to move from positive in theory to sensible in practice in the minds of sceptical investors.