The rising sophistication of ESG investors is a threat that wealth managers can’t ignore.

Few investment trends, if any, have genuinely galvanised a whole generation of investors like ESG (environmental, social and governance) investing has.

Portfolio managers are used to being in a position of power, where knowledge about investments is concerned, but the wholesale embrace of sustainable or ethical investing by clients means they will, in time, erode this knowledge gap.

Not only do clients know that they want ESG investments in their portfolio, but they are also starting to specify what type of ESG holdings they want, identify which managers are leading in the field, and whether they want an active or passive exposure.

This means that wealth managers may find it increasingly difficult to pigeon-hole their clients into a standardised model portfolio.

Embracing specialisation

Whilst there is arguably already a vast array of model portfolios that seek to address a wide variety of investor demands in relation to ESG investing, the complexity of the trend, and the increasingly bespoke desires of investors, means that specialisation will be increasingly sought-after.

For example, different clients will have varying views about how aggressively they want their portfolio to pursue net-zero goals, or to focus on social issues, or broader governance problems. And they may also differ in terms of how much ‘impact’ they want their portfolio to have; this being the balance between their desire for their portfolio to provide a financial return versus a social benefit.

Model portfolios can only go so far here, which means that wealth managers need to consider ways to create and monitor bespoke portfolios that can truly address their clients’ sustainability objectives.

One way of doing this could be to re-engineer the core/satellite approach for portfolios to make it relevant for the ESG age.

A clear strategy

Conventionally, wealth managers may have adopted an approach that puts the majority of a client’s assets in more mainstream assets (judged on the basis of performance, irrespective of ESG or non ESG), and then added small pots around this ‘core’ to enable exposure to riskier or more specialist sectors.

This strategy could also evolve into offering  bespoke ESG portfolios, whereby the core provides exposure to broad climate and ESG-related investments, while the so-called satellites more overtly target the client’s more specific requirements.

Of course, the beauty of this approach is that the core can have a tilt, too, if the client desires, enabling them to truly direct their investments towards the issues and causes they feel most passionate about.

Wealth managers may well agree that this vast optionality would be compelling for clients, theoretically at least.

But there may be reservations when it comes to considering how a firm could competently manage a myriad of different portfolios in a way that suits the client, keeps regulators happy, and is efficient. For some it may feel like a return to personally managed portfolios, with all the associated problems, which is what the rise of the model portfolio service was supposed to replace.

Robust management

The problem with choice and flexibility is its effects on other factors, notably volatility and tracking error.

Restricting your universe of investments, which is something that tends to happen the more precise the theme a client wants exposure to,often means increased risk, while also straying further from a broad,underlying market capitalisation index that the portfolio might be benchmarked against.

The future lies with technology. It is possible, through the use of specifically developed tools, to create a system where clients can have the portfolio they want within a systematic process that can be easily managed & overseen by wealth managers.

Portfolio managers can choose investments from their current buy-lists with pre-attributed ESG scores, to enable them to construct bespoke portfolios for clients that are any shade of ‘green’, while being sympathetic to the client’s risk and return desires.

In this way, technology can be seen as a way of enabling firms in providing clients with new products in new ways, rather than just the same product, more efficiently.

Crucially, such technology allows wealth managers to provide unbiased and transparent data about how ethical or sustainable their underlying investments are.

Such insight could prove vital when a firm is being questioned by its increasingly knowledgeable clients about the efficacy of their portfolio, or worse still, a regulator keen to find ESG investments that only talk the talk.

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