Thursday 02/04/2020

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Can responsible investment offer a solution for ultra-low interest rates?

Responsible Investment Strategist

Responsible investment is still regarded by some as a niche asset class, to which strategic portfolio allocation may grant a reduced percentage in function of the fads of the market. Against a backdrop of ultra-low interest rates, in which the quest for basis points often leads to an intense crackdown on costs, the allocation given to SRI even seems to be reduced. Hence, on the contrary, responsible investment should be integrated into the management process as a genuine management tool.

Responsible investment should be for sure integrated in the response to low interest rates, as it is integrated in the investment process as a genuine management tool. Hence, it allows for a better understanding of global risks.

Moreover,  SRI is not a cost resulting from a reduction of the diversification of the universes. In actual fact, it contributes to the risk/return ratio by making it possible to look for returns against the backdrop of low interest rates, but not at any price.

In the framework of active management, responsible investing, which is integrated both at the beginning and end of the investment process, first and foremost allows for another view on an investment. It also challenges the true intentions of management and its business plan, leading to a better overall understanding of risk remuneration.

The quest for yield has made many investors turn to emerging market debt since late 2012. In this asset class, a sustainable and responsible investment approach is very useful, making it possible to identify the countries posing the highest risks and featuring the most unstable debts environments.

In the past three years, which have been characterised by high volatility in emerging market debt, we have been able to demonstrate the added value contributed by our country sustainability filter. By vetting sustainability factors such as transparency and democratic values (1), population, health care and wealth distribution (2), the environment (3), education/innovation and the economy (4), we have been able to identify the countries which are best positioned in terms of sustainability. Moreover, we have been able to better assess the risks associated with the countries which score less well. In that respect, the filter demonstrates an important contribution to the alpha of the strategy during bear markets by stabilising the portfolio and eliminating tail risks. Thanks to this, the portfolio falls less than the markets (beta below one). During bull markets this contribution is lower, providing more leeway to the management expertise to show its value creation skills. Nonetheless, the contribution remains positive such that the portfolio benefits from a market rally with a beta of one.

The persistent low interest rates are also a result of low economic growth. Against this backdrop, it is recommended to look for high-quality companies. Sustainable companies are by nature quality companies, i.e. companies which are able to thrive in the long term and which integrate environmental, social and governance challenges into their activities.

On the one hand, the responsible investment analysis makes it possible to avoid the tail risks of companies which are not adequately prepared for tomorrow’s challenges. On the other hand, the companies which will thrive are the ones investing in innovation by leveraging today’s challenges into tomorrow’s opportunities. It is often said that a high-quality company mean an expensive share. However, it must be remembered that, although valuation in terms of price/earnings ratio may seem high compared to peers, one should not underestimate the superior growth potential such companies present in the mid- to long-term. After all, investors are prepared to pay more for growth. Such companies are innovative, competitive and have stronger pricing power than their peers, in particular thanks to having high barriers to entry. In the mid- to long-term it is corporate profitability that determines shareholders’ returns, meaning that the latter are prepared to pay higher premiums for more consistent growth.

Hence, sound selection of individual securities is of paramount importance and the interaction between the know-how of the management team and the responsible investment experts is key to making a global analysis of a company while taking into account all the challenges it is facing. In light of this, sustainable investment is not a niche but rather an integrated tool used to obtain a holistic view of a company with regard to its stakeholders.

So to summarise, responsible investing helps the management team in generating returns with a calculated risk while also offering a solution to the low-yielding environment.

Please see herewith an interview by Ophélie Mortier on the Forum de l’Asset Management in Paris on April 5th.