Climate Change 2011 Part 4 - Sustainable investments in private investors’ portfolios

Lars Kalbreier

Very much so. First of all, I would very much agree with Carlos that investors are moving away from a pure benchmark approach, or benchmark plus 200 basis points. Tracking is not really the trend in asset management. I think we are going more to the very much targeted, thematic funds where you are identifying a couple of investment themes and then you really focus your efforts in that specific area. The benchmark approach is probably best left to passive funds.

I think climate change offers, certainly, a wealth of different themes which not only interest investors or private clients just because they are fashionable, but they can also present very, very good investment opportunities. One specific example of that is resource efficiency. In fact, what I believe very strongly is that the low hanging fruit of combating climate change has nothing to do with the theoretical view of trying to combat climate change, but it is about having to deal with the consequences of climate change on different resources. The way you deal with that, or you will deal with that, is only through price. It is very nice to have lots of good intentions, but what is really going to be securing investment in that space is probably less government involvement, and more the price. These are the prices of different resources. This can be the price of carbon emissions. Only then the invisible hand of the market will start to fully work. So it is very good that the Governments are making steps in that direction, but at the end of the day, it will be about the price.

Now, if you look at specific subcomponents, like resource efficiency, this is very much the low hanging fruit of the whole debate. We have been looking at solar and wind and so on, but perhaps one of the reasons why solar and wind were not good investments is because there is a much more apparent and lower hanging fruit. If you look at the way we use energy and even resources such as water, we are just wasting it. We are using it in the same fashion that we used to use it, let us say, 50 years ago or 20 years ago. If you look at London, I see that 50 per cent of the water just trickles through the pipes, because the pipes are more than 100 years old.

We just need to revisit the ways we use resources including CO2 emissions, by using them differently and using them in a smarter way. I believe it is very easy for us to reduce our energy consumption by about 30 per cent, just by using them much more efficiently. That is really much easier than revolutionising the whole energy source system.

Now, the second angle to that would probably be the proper alternative energy sources, but it is going to take a really long time before we can start to use them. Some innovations are coming from the scientific backgrounds and we will start to see more and more of them in our daily life. The one I am thinking about the most is nanotechnology in solar cells, which is solar coating. You already have companies which have developed transparent solar panels in labs which you can apply to windows. Every window panel that does not have a transparent solar panel would potentially be just a waste of space and a waste of potential energy source. Right now it is still very expensive, but prices will be coming down and in the next ten to 20 years it is probably going to be standard. But that is way off, and it is probably too far off in terms of investment horizons. So, the low hanging fruit is really going to be about how we are using energy in a much smarter way.

Elisa Trovato

What has been the impact of the financial crisis on investors’, with regards to the ESG-type products?

Lars Kalbreier

One thing that I think is very important is that the financial crisis has triggered a move to back to basics and back to transparency. The thematic approach is tangible, it is something that clients can understand.

Thematic products are more transparent because you know how much you generate, how big the margins they make are and what kind of contracts they have for the next two or three years. And I believe that is partly also what has generated considerable interest in the thematic approach and thematic funds. The other thing is that if you look at what has been happening over the last three years or so, you notice that in fact, clients have become much more participative in the investment decisions than they used to in the past. Probably in the past, they relied on the relationship manager to make the investment for them, and they did not really participate that much. They are now also questioning the investment decision. So this more participative approach has brought clients and relationship managers to speak about themes, not only regarding diversification; because as we have noticed, diversification did not really work.

Elisa Trovato

Have investments in the thematic and sustainable investing space increased at the private bank, as a consequence?

Lars Kalbreier

I would say as a percentage of total investment, yes. There has been both an increase of investors and also of interest, as well.

Viktor Andersson

The product side is actually going to change the private banking industry slightly. High-net-worth individuals are increasingly becoming interested in what their money is doing, and they want to do good with their money. They do not want to invest in just a general plain vanilla SRI (Socially Responsible Investment) product. One reason why thematic products have worked in that space is because investors understand them and they see that they work towards solutions on the climate side, on the low carbon side, or on the water side. What I think is going to grow there is what Matt alluded to, ie the impact of the actual investments. So for example, the World Bank has issued several Green Bonds, available to the private banking market, which raise money for specific projects in emerging markets in the clean energy and sustainability areas. If you buy these bonds, that is where the money ends up. I think tangible and simple products like that will increase the interest of investors, because they can see the clear connection.

Elisa Trovato

Sarasin took the decision to make clients’ discretionary portfolios compliant with the SRI’s investment principles, two years ago. Is responsible investing a competitive differentiator in portfolio management in the private banking world? And how was it received by clients and advisers?

Andreas Knoerzer

At the end of 2008, the financial crisis was at full strength. We saw clearly that private investors in particular had been looking for more transparent and fairer products. Sustainable investing is a winner of the financial crisis and it is a way to differentiate ourselves from our peers and we can stay away from benchmarks. Our decision was actually very well received from the very beginning and supported by the relationship managers. We could prove that the performance was better with sustainable investing than with the classical approach. The response from our clients was very positive, too. We gave them the option to opt out if they did not agree. Only a handful of the 700 accounts with whom we started the business opted out. Since then, we have doubled the number of managed accounts, and we have grown in terms of assets from €1.8bn to almost €5bn in just two years. The response of the market and client relationship managers has been extremely positive but it is not just because of sustainability, it is because of taking active decisions. That is what you pay a private banker for. It is important not to hug any benchmark. It is also important to inform, write and report about what we do in a transparent way. And the performance has to be right.

Elisa Trovato

What are the challenges in implementing your decision? Can you actually manage a whole discretionary mandate in a sustainable way across all asset classes, including alternatives?

Andreas Knoerzer

We have two offerings. One is a pure solution, where we do not have commodity investments. The clients know that and they sign up to the contract which informs them what they can expect and what they cannot expect. It is very important that you are transparent. People do know that if they opt for the 100% sustainable portfolio, they end up with a higher portion of the portfolio that is technology driven and contains more mid and small cap stocks. The standard offering – although, we never use the term ‘standard’ in private banking – means that at least 75 per cent of the money invested is sustainable, but we do allow a classical asset allocation, investing in commodities.

We have also launched and looked at products in emerging markets in real estate and equity. Nowadays, actually, that can all be done in a sustainable way. Lars mentioned energy efficiency; green building is actually a very close link to real estate. At Bank Sarasin, in early 2008, we moved out of the hedge fund advisory business entirely. In terms of private equity, our involvement is only selective; even within climate change ideas you will find alternatives which have a certain sustainability angle to them.

The next challenge is to make sure that more and more of typical private banking asset allocation can be done in a sustainable way. But, in general terms I would argue, the products, with a few exceptions, are there. Now, it is really a question of implementing it.

Steve Triantafilidis

We developed a hedge fund of funds that is sustainable and we got some level of interest in that.

Carlos Joly

And that is why I think it is so interesting that you have taken the other approach, which is to say, ‘The default mode is to go into these funds. You can opt out if you do not like it.’ It has to do with the fact that obviously your management has taken a strategic decision that says, “To believe that there is a lower performance from these products is in some sense an outdated prejudice, and therefore, we will make that strategic decision on behalf of our clients.” Very, very few managers have done that.

Andreas Knoerzer

Our relationship managers have very little alternatives when selling a managed mandate. And whenever we use a pooled product from a third party, it is screened against sustainable criteria too.

Carlos Joly

And that is why I think it is so interesting that you have taken the other approach, which is to say that, ‘The default mode is to go into these funds. You can opt out if you do not like it.’ It has to do with the fact that obviously your management has taken a strategic decision that says, “To believe that there is a lower performance from these products is in some sense an outdated prejudice, and therefore, we will make that strategic decision on behalf of our clients.’ Very, very few managers have done that.

Elisa Trovato

What is it the key barrier to the further growth of sustainable products in high net worth individuals portfolios? Should the private banks offer more training to client relationship managers on the topic of sustainable investments?

Viktor Andersson

The main barrier, in any organisation, be it corporate banking, institutional clients or private banking, is sales people and relationship managers. How do you incentivise the relationship managers? The reason for this is that the amount of time relationship managers can spend to learn about every new product is limited, regardless of whether your client is a high-net-worth individual, a large corporate or an asset owner. In addition to that they have to learn about sustainability and the related products, because they would never want to go into a client meeting and present a sustainability product, or any other product, they do not understand. They do not want to sit there and talk about things that they do not appear to know. So you have to take time off from their rather busy agenda and teach them sustainability.

Elisa Trovato

Should this be a strategic decision of the management board?

Viktor Andersson

It has to be a strategic decision, and it has to be incentivised. They will not do it otherwise. And in order for the management to do that, they have to believe in it, from a long-term strategic perspective. If they don’t, then they will not take that time off from the relationship managers to teach them about these products or this field.

Elisa Trovato

Do you incentivise the relationship managers at SEB private bank to promote these sustainability products?

Viktor Andersson

We are not incentivising the relationship managers per se. I collaborate instead with the ones that already show an interest in sustainability products either on a personal or a professional level. So you start with them, and then they can become ambassadors of the sustainability products, and if you have a couple of success stories, you can approach others with them. Also a strategic management decision can encourage the relationship managers to promote the sustainability products.

Matt Christensen

You said that they have to be incentivised. What would be the incentive for you? Can you give us an example?

Viktor Andersson

That is the million-dollar question. You can require them to always have at least one sustainability product in their portfolio. When they meet with a client, they have not only their favourite products to present, but also one or two sustainability products, when applicable of course. In the beginning when I was with ABN AMRO, we often discussed this issue. Private clients in particular would say to their relationship manager, ‘I am really interested in sustainability. I want to invest in sustainability products’. The relationship manager would then start digging around in the database and come up with three to four products, from the main competitor. They did not even know that they had their own sustainability products. Financial incentives are often very effective, but there could also be a value in strongly enforcing the rule that the relationship managers always have to have a sustainability product in their portfolio, even if clients don’t specifically ask for it.

Andreas Knoerzer

The starting point is actually having the ambassadors to make a strategic decision. There is no choice between selling a sustainable mandate or not; the only question is, ‘Is it the pure one or the classical one?’ It is about how we, as a bank, ensure that they sell more mandates, rather than just going with the advisory ‘pick up the phone’ business. Ultimately, that is a management target. Relationship managers are measured on how much new money they bring into the bank.

Another question is how much money is in our own products. Only 2-3 per cent of our assets are in Sarasin’s own products, which is very, very little. It is not about product-pushing. Even if we reach 10 per cent, it is still very low.

Carlos Joly

It is a sales management push issue, not a demand issue.

Elisa Trovato

Viktor, at SEB private bank do you too tend to use mainly thematic funds that include this sustainable element?

Viktor Andersson

I think there is a general market trend that the large bulk has been the plain vanilla SRI funds, and this is still the case. But clients are getting more sophisticated, in the sense that, again, they want to see what their money is doing, be it by thematic funds or by more impact investment products. I think they appreciate being able to tell a story. They can say that they invest in this product, and then they can explain the product and tell a story around it. For institutional clients, having a product like the Green Bonds in their portfolios also gives them something concrete to report in their PRI Reporting and Assessment surveys.

Elisa Trovato

Thematic funds like water or clean energy are more used as satellite investments in portfolios, and they just take a very small part in the portfolio. Whereas what Sarasin is doing is managing the whole investment portfolio in a sustainable way. Is selling a story enough for implementing responsible investing in portfolios?

Joost Bergsma

Selling a story is not enough. Clearly, there has to be a lot more to it. It is the icing on the cake, I suppose. But, it is easier to explain how a wind fund works as opposed to, let us say, a long-short hedge fund. An advantage that a thematic fund has over traditional SRI investments, is that it is very tangible. You can explain an energy efficient building; you can see the wind farm; and you can very easily explain how the economics work and what the drivers are. And that appeals to today’s investors. I think investors today are weary off very quantitative models, charts and these kinds of less transparent indicators. It has not really worked. Everybody said that their sophiscated investment tools were uncorrelated. Institutional investors tell us: ‘We like it because it is hard assets. We can see the assets and we can see how the wind farm works.’

Our client base is predominantly institutional and what you see is a trend of passive indexation of the bulk of the portfolio and then use really non-correlated – which I think is where thematic comes in - active investments generating the alpha in the portfolio. Perhaps that is also what you will see more and more, on the private client side.

Andreas Knoerzer

We are actually seeing tremendous growth. A year ago we launched a Swiss real estate product. We did a fundraising second round at the end of last year. We have been looking for just SF100m because that is the money we needed to build new projects. We got subscriptions for SF250m. So we have a waiting list of potential investors who would be happy to jump in. The reason why is not just sustainability but because there is an appetite from pension funds for real estate, and there is also an appetite for income distributing products, which comes down to the energy project on the infrastructure side. That is something you can achieve by investing in wind and solar parks. It is not just the touch and feel of sustainability; it is the underlying financial needs the investors have, which is a predictable income. But it is a perfect marriage in that sense.

Joost Bergsma

Exactly, and that is where the conversation starts. The conversation starts with: this is a reliable stream of income from real estate and clean energy, and at the same time, it is hard asset, and at the same time, it is sustainable. I think that appeals very much in today’s market.

Elisa Trovato

The sustainable investing market is still largely dominated by institutional investors. Do you expect growth on the private banking side? What are the key barriers to the further growth of sustainable products in high net worth individuals’ portfolios?

Matt Christensen

One of the findings from the recent Eurosif HNWI & Sustainable Investment Study - which we have run twice, in 2008 and 2010 and Sarasin was one of the sponsors – is that HNWI investors tend to move from a satellite to core approach over time in the adoption of sustainable investment in their portfolios. Since the previous study, ‘toe-dippers’, with only marginal sustainable investments, less than 1 per cent as a part of their portfolios, have migrated into ‘shallow water swimmers’, with sustainable investment in their portfolio between 1 per cent and 20 per cent now approaching 60 per cent of the surveyed respondents. Some of this group will migrate still further upstream to become core sustainable investors; over 10 per cent of the HNWI respondents can be classified as ‘pure sustainable players’ – or core - with more than 50 per cent of their portfolios invested in sustainable products across all asset classes.

Let us forget the whole default option you have at Sarasin and just take a typical investor. They generally want something tangible and so the thematic has been a very easy way to sell this whole sustainability idea, because it is something that you can really point to and say why you are doing it and what the benefit might be. That was not such a big surprise, what was interesting though is that once those investors start doing an investment in say, a theme fund, they then start to learn about the field, and then their interest in it does grow over time, to then say, ‘Well, let us look at it across a different asset class, or across what we can do within equities.’

So I think the happy part of the story is that yes, institutional is the key market when it comes to sustainability, but nevertheless, the wealth management space is a growth area. We have definitely seen growth; it is just coming from a very low base. Part of that is because generally when it is a best in class fund, which is the way it really started in many parts of Europe, people had trouble understanding what that meant, and I think it is a hard sell. And so I think they might get to the best in class idea from a different door.

Carlos Joly

But the problem with the best in class approach is also that it is difficult to understand in many instances, and also it is often a disguise for something that ends up not being that much different, unfortunately. Because when you look at the list of companies that end up in a best of class fund and you compare that to a traditional fund, it is not that much different.

Andreas Knoerzer

You have to explain what is not included. That is the problem.

Carlos Joly

But the thing is that when you see that the portfolios are not that much different, people start questioning, ‘What is this whole sustainability language? Is it a disguise?’ And that is where the thematic approach is completely different. It is a high conviction approach that does not follow a benchmark or traditional index approach. And that is why I think the interest is in that direction, and not in the previous generation of SRI investment product, that you are calling sustainability funds. If you were to ask 20 people what they really mean by that, you would get probably ten different answers. And then there is a lot of opacity in what are called sustainability or best in class funds. Because, even if an asset manager will say, ‘Well, we include the following criteria,’ they never go into, ‘How do I weight the following criteria in each sector? How much weight to the social factors vs the environmental factors, and how much weight to these particular social factors? How much weight to the environmental factors and those particular environmental factors?’ Even though you can have two asset managers that say that they attend to the same criteria, they give different weightings to these criteria.

Steve Triantafilidis

I have to disagree a bit. In terms of our sector approach we have refined the approach to look at that specifically, sector by sector, because the environmental, social or governance factors are not the same in each sector. Therefore, we do take that into consideration in a quantitative manner when approaching this, as we see clear differences between sectors as to what is important. I think for the theme to be relevant of sustainability generally, we need to make it much broader than just a thematic approach or elements of the thematic, because it is seen as narrower, and it would be much better for it to be broadly accepted into mainstream investing.

Carlos Joly

Do you believe that all sectors of the economy are sustainable?

Steve Triantafilidis

All sectors? No.

Carlos Joly

Okay, so do you make decisions to exclude certain sectors from an investment portfolio?

Steve Triantafilidis

Sometimes.

Elisa Trovato

For example, which sectors do you always exclude?

Steve Triantafilidis

We exclude tobacco or cluster bombs/landmines, for example.

Carlos Joly

Let me ask you a tough one. The argument could be made that banks have been externalising social ills. Many observers have said the banks socialize their losses and privatize their profits and that the major money center banks have been a central cause of the crisis we are in through irresponsible lending and securitization. Are you willing to say that because of those behaviours and actions, those banks cannot be considered part of a sustainable investment proposition?

Steve Triantafilidis

Looking at the behaviour of many banks, we agreed that it proved that they did not have sustainable business models. That is an historical view, looking back, but the question is, what are they doing now? Have they changed behaviours?

Matt Christensen

It is the BP question.

Andreas Knoerzer

Carlos, I do agree. I always receive the same questions with our more blue-chip orientated fund. I have to say, we never go for hardcore best in class, we always have a different approach, but at least we do have products that cover a broader range of industries and have a bit more classical diversification. Obviously, we do get the question: ‘What is the difference if IBM, Intel and some of the classical names are in it?’ And I usually say, ‘The better way to explain it is by saying which companies did not make it in.’ If we only did the thematic driven approach, we would limit ourselves and only get a niche position. I would say there are benefits from what we do for broader scale products and investors. I am a fan of having both offerings. However obviously I do see that you have a greater chance of becoming more of a thematic driven investor than a classical one, because there is no need to be close to a benchmark. However, we should not forget that big institutional investors have other financial targets, such as not allowing more than an x per cent tracking error. So what do you say, ‘No, thank you,’ or do you say ‘I will try to come up with the best I can do in order fulfil your needs?’

To have an offering for the ‘tip-toe’ investor’. I see as a good starting point, especially in markets where a lot of the clients are pretty much advisory, particularly Asia and the Middle East. In Asia, clients are traders; they do not give you a mandate. They would like to be advised. So you can catch them if you have a sexy theme, and that obviously could be climate change or it could be water. Then you have a fantastic thematically driven product as a starting point. But the only thing you can sell is, ‘This is the outperformance you will make because of...’ In our markets, I would argue – and therefore we changed the whole thing – the tip-toeing is only a partial solution. It is also a bit of a disguise, in a way. So actually in our markets, we just said, ‘Let us not just go for that. We offer the client what we can do best, and that is what we can do best.’