Why active multi-strategy investing can overcome ESG challenges

Multi-strategy ETFs give advisers a valuable tool for helping clients with an ESG mindset to invest in global equities.

Two key principles can help optimise outcomes for investors seeking to build a sustainable global share portfolio: active management and multi-strategy investing.

These principles, when combined with the benefits of an exchange-traded fund (ETF) structure, can help overcome common challenges faced by investors focused on Environmental, Social, and Governance (ESG) factors. These challenges can include investment style bias, drawdown risks, and difficulty accessing high-quality investment managers.

New evidence that advisers more often recommend passive ESG funds suggests these principles are not well understood. Morningstar research shows that sustainability funds around the world won net inflows of US$662 million in the March quarter – driven primarily by appetite for passive strategies.¹

There are several reasons why an appropriate portfolio of global active equity managers may yield the results sought by advisers.

First up, active management allows the deliberate security selection that is paramount to investors who take ESG principles to heart. Increasingly, these investors demand that inclusions and exclusions in their portfolios are thoughtfully considered. Active management looks further than just the numbers, conducting in-depth research into securities, for example by meeting company management and reviewing governance standards to ensure every stock selection aligns with a deliberate investment process and philosophy.

Secondly, active managers tend to engage more with the companies within their portfolios than the typical passive manager. This regular dialogue helps to achieve the transparency and impact sought by end investors.

Russell Investments' 2023 ESG Manager Survey – which polled 169 global firms with $US20 trillion under management – found active ownership has become the top ESG information source for fund managers across the board.

Counteracting bias

Active managers with ESG focused investment strategies have natural style biases. The heavy weighting of some sustainable funds to growth stocks is an example of the possible extent of such a bias.

The upshot is an individual active manager can generate returns which are more volatile than many investors desire. In other words, individual active ESG strategies can come with a significant amount of benchmark-relative risk.

But this is where multi-strategy investing comes into play. A diligent selection of complementary managers can help to balance out bias to particular styles – such as growth companies, large cap stocks or developed markets – and help produce less volatile performance than a single active manager.

A well-constructed portfolio will include, for example, not just growth managers but also value managers with an equal commitment to sustainability. By combining multiple managers' portfolios into a single portfolio – where each manager provides their investment ideas, but the multi-manager executes the actual trades – turnover and currency transactions can be minimised. More importantly, this approach offers a more balanced and diversified exposure to global equities.

A well-resourced multi-manager can scour the world for institutional grade investments that are not typically available to retail clients and ultimately generate more consistent returns than otherwise possible.

All this can be achieved while still pursuing excess returns above a chosen benchmark. And, in an exchange traded fund (ETF) format, the potential benefits can extend beyond more than just performance.

For example, the full holdings of an active portfolio can be disclosed on a daily basis in exactly the same way as passive ETFs – giving people 24/7 transparency about where their money is invested. The lower minimum investment applicable to ETFs can also be a distinct advantage.

There is much more to sustainability investing than first meets the eye. It adds a layer complexity for investors. Multi-strategy investing can overcome these complexities by capturing the strategies of multiple high-conviction global equities managers considered to be specialists in ESG investment.

It is a much-needed skill that provides advisers with a valuable tool for helping clients with an ESG mindset achieve their goals.

¹ Global Sustainable Fund Flows: Q1 2024 in Review, Morningstar.