Building a sustainable portfolio

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Sustainability is the ability to meet the needs of the present without compromising the ability of future generations to meet their own needs.1 

This becomes a key element across many areas, including business strategy, lifestyle and consumer behavior, philanthropic activity, and investment mandates.

Global sustainable investing assets under management (AUM) reached over US$30.3 trillion in 2022, amounting to about 24% of total AUM.2  

This figure is expected to continue growing, driven by regulatory changes, data enhancement and technological enhancement.

Sustainable investing provides a unique opportunity for investors who seek to:

  • Reflect their values and worldview onto their investment decisions

  • Mitigate investment risks associated with Environmental, Social and Governmental (ESG) issues

  • Access the competitive returns that sustainably operated companies may generate over time 

  • Gain investment exposure to innovations driving environmental and social progress

  • Generate an incremental impact in the world

Increasingly, a growing pool of  investors are looking to achieve all the above.

What is sustainable investing?

 

The term ‘sustainable investing’ has, over the past two decades evolved into a collective descriptor for a range of approaches. 

Each approach has its own financial and sustainability objectives and is available across traditional and alternative asset classes. 

At Citi Wealth, we classify sustainable investing into four main approaches – Socially Responsible Investing (SRI), ESG Integration, Thematic Investing, and Impact Investing. 

These approaches are not mutually exclusive to each other, and a single investment product can combine multiple approaches to target exposure specific to what resonates with an investor. 

  1. Socially Responsible Investing, or SRI, refers to exclusion of companies or sectors based on specific values or norms. Common examples are the exclusion of tobacco, fossil fuels and weapons. 

  2. ESG Integration uses specific and measurable ESG metrics as an integral part of the investment process to identify opportunities. For example, by identifying companies with the strongest ESG attributes or companies poised to benefit from changing ESG metrics.

  3. Thematic Investments look to access strategies that are aligned with specific sustainability themes, like access to affordable healthcare, climate change, or water access and protection. Under the thematic approach, investments are made in companies that are deriving revenue from creating strategies to address sustainability outcomes.

  4. Impact Investments are based on a selection of strategies that are designed to deliver a potential financial return as well as a measurable, intentional, and incremental impact in one or more environmental or social areas.

Can a sustainable investing strategy be profitable?

 

A common misconception of sustainable investing is that performance has to be sacrificed.

Numerous studies, such as a report by the NYU Stern Center for Sustainable Business, found that sustainability initiatives such as low-carbon future planning, improved innovation, and risk management on ESG issues help to drive corporate financial performance. In fact, sustainable investments also provided potential risk mitigation, especially during a social or economic crisis. 3

Like traditional investments, different sustainable investments offer varying levels of financial outcomes and are exposed to market risks. ESG and sustainable investing may limit the type and number of investment opportunities, and, as a result may affect performance relative to other approaches that do not impose similar sustainability criteria.  

However, the risk adjusted returns are determined by factoring in relevant ESG-related risks in addition to market risks. Furthermore, sustainable strategies that invest in companies striving for the best ESG practices may shield themselves from evolving ESG-related risks down the road.

How can an investor build a sustainable investment portfolio? 

 

Start by establishing the goals. This will help to define appropriate investments as well as set criteria to measure their progress over time. 

Sustainable investing has dual goals. First, decide on the overall investment objectives – identify return expectations, risk tolerance, and liquidity, currency, and geographical preferences. Once these are established, it is time to reflect on the sustainability objectives.

Here are some questions to help align a portfolio with sustainability objectives:

  1. What does sustainability mean to the investor?

  2. Are there any particular sectors or companies that should be avoided?

  3. What outcomes are important? Are these outcomes regional or global? Are there any specific themes to explore within the portfolio, such as gender, clean water, or renewable energy? 

  4. What are the suitable investment vehicles according to the investment objectives outlined?

At this stage, an investor can also decide how much of the portfolio to dedicate to sustainable investments. Should there be a sustainability lens to just a portion of the portfolio or across the full suite of investments? 

Once the investments are narrowed down, the next step is to do due diligence. Simply because something is labeled as “sustainable” or ESG-related, does not mean it aligns with the intended values and goals. 

Evaluate the investments’ alignment with the desired financial and sustainability objectives and be aware of any potential risks and exposure to controversial sectors. 

Over the course of the investment period,  conduct periodic assessments, including reviewing any impact/progress reports available and analyzing the impact of incorporating sustainability into the portfolio, to ensure that the portfolio remains aligned with stated financial and sustainability objectives. 

KEY TAKEAWAYS:

 

Sustainable investing provides a potential opportunity for investors to align their portfolios with their worldviews, mitigate potential sustainability-related risks and/or capitalize on innovations that support sustainable development.

There are four main ways to approach sustainable investing – Socially Responsible Investing, ESG Integration, Thematic Investing, and Impact Investing.

Investing in sustainably operated companies and sustainable investment strategies limits the type and number of investment opportunities but could provide potential risk mitigation and mitigates against ESG-related risks to a greater degree than non-sustainably operated companies.

There is no one approach to sustainable investing, and no single approach towards building a sustainable portfolio. It is an evolving journey for investors to take to transit their portfolios towards sustainable investing.

 

 

 

 

1  Definition of Sustainability by the United Nations Brundtland Commission

2  Global Sustainable Investment Review 2022, Global Sustainable Investment Alliance

3  New Meta-Analysis from NYU Stern Center for Sustainable Business and Rockefeller Asset Management Finds ESG Drivers Better Financial Performance

 

Important Information

Environmental, Social and Governance (ESG) and sustainable investing may limit the type and number of investment opportunities, and, as a result may affect performance relative to other approaches that do not impose similar sustainability criteria. Sustainable investment products are subject to availability. Certain sustainable investment opportunities may not be available in all regions or not available at all. No guarantee is provided regarding the financial or sustainability performance of such products and the products may not meet their investment or sustainability objectives. 

Investment strategies, portfolios and products offered via the Citi Global Wealth Investments’ (CGWI) sustainable investing platform, Investing with Purpose (IwP), meet CGWI’s defined criteria for a sustainable investment. Every sustainable investment on the IwP platform incorporates one or more approaches: Socially Responsible Investing (SRI), Environmental, Social and Governance (ESG) Integration, Thematic, and Impact. 

At CGWI, we define the four approaches to sustainable investing as follows. Socially Responsible Investing (SRI) involves the exclusion of sectors or companies that may not to be aligned with sustainability values or objectives. The investment mandate must explicitly state the intention to exclude certain exposures to such sectors, industries and products based on values-related criteria. 

ESG Integration uses ESG data and metrics to identify investments with potentially attractive risk and return characteristics. Investment mandates will incorporate ESG risks and opportunities that are considered material and integral drivers of investment decisions into their investment process. Managers of ESG integration strategies may directly engage with portfolio companies and / or use their proxy votes to help drive positive ESG outcomes.

Thematic investments access exposure to investments aligned to sustainable themes such as climate change or access to healthcare. Investments seek alignment to sustainable themes through their business lines as demonstrated by their current and future revenue exposures. 

Impact investments demonstrate measurable impact in a particular environmental or social area. Investment mandates not only state intent, but also manage to a desired sustainable outcome by providing measurable environmental and/or social metrics alongside a potential financial return. To be considered ‘impact’, the outcome must be incremental, meaning it would not have occurred had the investor’s capital not been allocated to the investment. 

A single investment product can combine multiple approaches. These approaches may limit the type and number of investment opportunities, and, as a result may affect performance relative to other approaches that do not impose similar sustainability criteria. Sustainable investment products are subject to availability. Certain sustainable investment opportunities may not be available in all regions or not available at all. No guarantee is provided regarding the financial or sustainability performance of such products and the products may not meet their investment or sustainability objectives. Strategies and products must meet certain criteria for sustainable investing to be marketed as such on CGWI’s IwP platform. Investments outside the IwP platform may still consider sustainability criteria in the investment process, such as potential impact of climate risk on investment value.

There is currently no globally accepted framework or definition (legal, regulatory or otherwise) nor market consensus as to what constitutes, an “ESG”, “sustainable”, “impact” or an equivalently labelled product, or regarding what precise attributes are required for a particular investment, product or asset to be defined as such. Different persons may arrive at varied conclusions when evaluating the sustainability attributes of a product or any of its underlying investments. Certain jurisdictional laws and regulations require classifications of investment products against their own sustainability definitions and as such there is likely to be a degree of divergence as to the meaning of such terms. For example, the term “sustainable investing” where used in this disclosure is by reference to CGWI’s internal framework rather than any defined meaning under jurisdictional laws and regulations. There is no guarantee that investing in these products will have a sustainability impact.

There are numerous ESG data providers that evaluate companies on their ESG performance and provide reports, ratings, and benchmarks. Report, rating and benchmark methodology, scope, and coverage, vary greatly among providers. ESG data may not be available for all companies, securities, or geographies and as such, may not necessarily be reliable or complete. Such data will also be subject to various limitations, including (inter alia): i) limitations in the third-party data provider’s methodologies; ii) data lags, data coverage gaps or other issues impacting the quality of the data; iii) the fact that there are divergent views, approaches, methodologies and disclosure standards in the market, including among data providers, with respect to the identification, assessment, disclosure or determination of “ESG” factors or indicators and which precise attributes are required for a particular investment, product or asset to be defined as such; iv) the fact that ESG information, including where obtained from third-party data providers, may be based on qualitative or subjective assessment, and any one data source may not in itself represent a complete ‘picture’ for the ESG metric that it represents; v) the fact that such data may be subject to change without any notice of this to CGWI by the third-party data provider or other source. Furthermore, some of the data CGWI obtain from third-party providers is not obtained directly from investee companies, but rather represents estimated / proxy data that the third-party data provider has prepared using its own proprietary methodologies (e.g. because there is no actual investee company data). Such proprietary methodologies are also subject to various limitations of their own, acknowledging that estimates / proxies are in and of themselves an inexact science. CGWI does not make any representation or warranty as to the completeness or accuracy of any such third-party data (whether actual or estimated), or of data that is generated using this third-party data. CGWI shall have no liability for any errors or omissions in the information where such information has been obtained from third parties or not.

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