1. Introduction

The capital market is undergoing profound changes: In addition to the current impact of the COVID-19 crisis and the regulation, (socio)political issues are getting more and more attention. One of the main topics is the question of alignment of investments towards sustainable criteria, especially in the light of climate change. Here, too, regulation is becoming increasingly active and is making initial specifications for the definition of and reporting on sustainability in investments. However, all market participants expect further measures to be taken.

  1. Asset Management

The implementation of sustainability criteria in the processes of the asset management industry is relatively advanced compared to wealth management. Products and investment strategies that are managed according to these criteria, e.g. taking into account environmental standards such as resource consumption, social standards or the United Nations’ sustainability goals (Sustainable Development Goals), can now be aligned and managed according to these criteria across the entire value chain.

Thus, the investment process for a sustainable investment strategy already starts with the appropriate selection of the investment universe. Using filters and exclusion criteria, unsuitable titles can be sorted out at the outset, for example, manufacturers of controversial weapons or issuers with particularly high CO2 emissions. Subsequently, classical elements of fundamental and/or quantitative valuation can still determine the composition of the portfolio, but the selection principle, e.g. best-in-class, and investment strategy, (CO2 reduction, resource conservation, etc.) will form the basis of portfolio construction. Even very large asset management houses often buy the necessary data basis externally and, in some cases, “refine” them internally. Although the granularity of the information now makes it possible to narrow down criteria precisely, there are still “white spots” for certain asset classes and regions, for example in the emerging markets, where it is not possible to make reliable statements on some criteria due to an insufficient database. However, dynamics in these markets, starting from a lower level, are particularly high, as the catch-up potential has been recognized by market participants.

In addition to classic risk management instruments, such as derivatives overlay or loss protection through defined trigger levels, it is becoming increasingly apparent that investors appreciate the implicit protection against certain risks through investment strategies geared to sustainability. The impact of individual tail events (see Deepwater Horizon, Fukushima, etc.) can be reduced or avoided altogether by deliberately excluding certain sectors. Besides, the current corona crisis shows that structural advantages can also be identified through sustainable investments. For example, the sustainability-oriented version of the MSCI World lost significantly less value than the comparable standard index both in March 2020 and over a period of twelve months.

When it comes to reporting on sustainable investments, there are numerous options, since a large amount of data is available. This has been supported, among other things, by the EU taxonomy, a classification of sustainable economic activities adopted at the end of 2019. The challenge here is to process the large number of data points consistently, which often come from different sources and need to be harmonised through a single database. However, it is then possible to report in detail on e.g. water consumption, gender diversity, the carbon footprint or the management (governance) of a company.

  1. Wealth Management

In wealth management, the holistic advice and support of wealthy and very wealthy private clients, sustainable investment strategies play an increasingly important role. For example, through “impact investing”, where funds are invested directly in education, health or social projects with a measurable sustainability effect. In addition to the increasing pressure from client demand, competition in this segment is also a driver of development, as hardly any asset manager can afford not to be able to deliver in terms of sustainability nowadays.

In general, however, many past developments can be traced back to regulatory requirements, such as the introduction of MiFID II and the associated transparency of costs or the obligation to keep records of advisory discussions, even if these have caused some difficulties in practical implementation.

The most recent regulatory development supporting this transformation relates to the sustainability of financial investments. For example, the EU Action Plan for the promotion and financing of a sustainable economy, which was adopted as early as 2018, has, among many other points, ensured that investors are advised based on their preference on sustainability. Therefore, the discussion with the client on this topic will have to be an essential part of high-quality advice in the future, which requires full integration into the advisory process. Different characteristics, such as the only implicit consideration of ESG criteria via dedicated ESG funds (best-in-class or exclusion) or the commitment to the sustainability goals of the United Nations (Sustainable Development Goals) probably cannot be answered with a single question.

Even if some things have changed in terms of processes, the portfolio or portfolio construction is still most of the time the focus of the advisory process. Thus, in many cases, “thinking from the end” is conducted, where actually the “way” to get there is decisive for a high-quality result. This path must lead along a modern risk profiling via the holistic recording of assets and liabilities, must take investor objectives adequately into account and, in addition to the ESG criteria mentioned, must also address other investor preferences, such as active vs. passive, quantitative vs. fundamental investment style or boutique approach vs. big player.

  1. Conclusion

It is to be expected that the regulatory pressure (see EU action plan above) in wealth management on the subject of sustainability will trigger significant changes in the advice given to private investors. If not necessarily in the procedural handling, where many providers have repositioned themselves in the course of the MiFID II implementation and are prepared for changes, then at least in the direct exchange with the client. How wealth managers implement the sustainability preferences will be crucial for their differentiation in the market and their competitiveness in the long term. Clients will be aware if a wealth manager identifies with the concept of sustainability or if the issue is thought of as a mere “hygiene factor”. The socio-political discussion will contribute further to this and increase the need for action, also on end clients.

The discussion on the clients’s point of view on sustainability should be conducted at the beginning and as detailed as possible. Contemporary profiling of the end clients, which goes beyond regulatory standards, provides the appropriate framework for this and, if properly designed, can lead to value add information also for the advisor.

Ideally, the effects of climate change should be explicitly taken into account, since the long-term rise in global temperatures will have a massive impact on future returns and risks and will have a significant effect on the prosperity of individuals and the society as a whole. Sooner or later, all market participants will have to adapt to this regime change. We will publish another article on this subject in our blog in the near future.

With the right tools, these challenges can not only be mastered but also implemented to the benefit of clients and advisors. Modern software that ensures a holistic integration of the sustainability issue enables the consideration of assets and liabilities, takes life events and goals into account and can include climate change in various forms in the calculation of individual strategic asset allocation is the future-oriented solution, either stand-alone or in conjunction with existing systems.

  1. Additional Information


Holger Pötschke

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