
Summary
Our ESG team examines systematic evidence demonstrating that actively managing ESG tail risks may help to deliver sustainable investment performance over a market cycle.
Key takeaways
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ESG and your portfolio: Managing tail risks through active integrated ESG investing
Astute corporations recognise the importance of environmental, social and governance (ESG) factors for future business success. Investors, too, are paying attention to ESG factors. Incorporating them into investment decisions seeks to provide higher risk-adjusted returns over a market cycle. In some places, such as the EU, there is pending legislation that requires that all funds are ESG risk-managed going forward. Investors are still trying to understand how to fully unlock the performance potenial of ESG risk integration into investment portfolios.
A recent AllianzGI study with a focus on ESG tail risks aimed to find out which process of ESG integration looks most promising.
To understand how ESG factors may affect portfolio risk and return, we analysed historic investment performance of European and global equity portfolios between 2008 and 2018. The study looked at three different areas related to ESG risk factors. First, we provided evidence for the materiality of ESG factors from a risk rather than a reward perspective. ESG is priced on the downside rather than the upside. Second, we analysed which lens investors should use to see how ESG portfolio risks affect their investment performance. Third, we examined the value of active investing and stewardship through corporate engagement and proxy voting.
We largely framed ESG risks in the following manner, which helped us to address and examine ESG portfolio risk in-depth.
ESG Risk | Macro | Sector | Portfolio | Idiosyncratic |
---|---|---|---|---|
Financial Impact | Loss of gross domestic product | Sector devaluation | Portfolio tail risk | EPS revisions credit downgrades |
Modelling | ESG extended econometric models ESG Integrated assessment models | Sector ESG materiality framework (SASB/ proprietary) | ESG (tail) risk portfolio modelling | ESG extended DCF models ESG in credit ratings |
Real-life examples | GDP at risk due to climate change | Coal sector devaluing | Carbon price stress testing | Daily newspaper |
Regulatory ESG Risk (i.e., ESG litigation, CO2 tax and trade) | ||||
Applies to nearly all asset classes |
Our research indicated three clear results.
As a starting point, our research sought to answer whether portfolios that build on lower ESG risks have generated stronger returns compared to those that are exposed to higher ESG risks. Our findings, which are in line with other academic research on the subject, show that simply skewing portfolios to better ESG-risk-scoring holdings has not generated higher returns. However, our research provides good evidence that, historically, portfolios with a higher ESG risk profile have shown significantly more financial portfolio tail risk versus benchmark portfolios.
Accounting for ESG factors in your investment portfolio may be an effective way to generate alpha by helping to manage downside risks. Avoiding large portfolio drawdowns by ESG risk management has historically contributed to better risk-adjusted returns. The analysis, however, did not provide any significant correlation between highly rated ESG factors and outperformance vs benchmark.
Understanding the source of ESG risks and opportunities is key. We examined how different ESG risk scoring portfolios performed according to their extreme loss expectations: what is the difference in financial damage incurred in the worst 1% and 5% portfolio loss events? What is the difference in maximum portfolio drawdowns?
In doing this, we found that the relatively better ESG-risk-scoring investments have delivered a very similar risk profile compared to the benchmark. This is not the case when it comes to low ESG-risk-rated portfolios. The significant difference is in the lower tranche, indicating the importance of ESG as a source of tail risk. This may be addressed through fundamental research and active management.
It is important to note that, in our view, ESG risk is not about average portfolio risk, but instead about extreme events that are financially material and stem from an ESG-related source.
Our research provides further evidence that investors should not rely solely on investing in companies with high ESG ratings or simply avoiding high-ESG-risk holdings. There is evidence that a simple passive or tilted ESG strategy would actually overpay and would concentrate assets without exploiting an additional return potential. To address ESG risks attentively, there are a host of ESG factors that investors must consider, including constantly changing macro and regulatory dynamics, corporate fundamentals and market and political events that might play a part in future performance. We are convinced that active management that makes a judgmental risk/reward trade-off on ESG risks, i.e. properly incorporating ESG factors into portfolio composition, leads to better risk-weighted returns.
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Active is: Finding new sources of income
Adjusting to a lower-for-longer rate environment

Summary
A low-growth, low-interest rate environment is firmly established globally, and a combination of external forces look set to inhibit any improvement for years to come. This makes investors’ hunt for income more complicated than ever.
Key takeaways
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Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Investing in the water-related resource sector may be significantly affected by events relating to international political and economic developments, water conservation, the success of exploration projects, commodity prices and tax and other government regulations. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
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