Within the Asset Allocation team, we believe that climate change presents both urgent challenges, as outlined in LGIM’s latest CIO update, and appealing investment opportunities – some of which are unique to our multi-asset capability and particularly relevant to the current macro environment.
As a result, we have adopted investment themes that, in our view, are likely to benefit from and hasten the global energy transition, deploying our portfolios in the fight to avert a climate catastrophe. We have also continued to try to future-proof those portfolios against broader ESG risks.
A longer cycle
Our medium-term view on risk assets remains bullish, because we believe the global economy is in mid cycle, consumers have excess savings to spend, investor positioning is quite neutral, and central-bank support is still plentiful.
Although the momentum of economic growth is fading, our research suggests this does not necessarily mean lower equity markets. At the same time, earnings momentum remains favourable, allowing valuations to drift lower while markets grind higher. Finally, recent recession indicators also point towards a slightly longer cycle than previously anticipated.
Still, markets have had an extraordinary run since the lows of March 2020, meaning it is more important than ever for us to identify new investment themes and strategies to generate sustainable, long-term returns for our clients. I’ll highlight two examples here.
We have built a basket of 25-30 stocks that, in our view, should benefit from the increased focus on decarbonisation and more explicit and realistic pricing of carbon emission costs, from clean energy generation to storage batteries. We aim to capitalise on this multi-trillion-dollar opportunity, which we see as a massive growth theme for the medium term, especially against a backdrop where economic output remains tepid.
By this, we mean timberland companies that own forests and the associated lands as their main assets. Trees are a renewable resource that offer a sustainable solution to many products that the world demands. Moreover, responsible management of forests does not just protect the trees, but also the wildlife and ecosystems that depend on them. Forestry also exhibits low correlation and betas to equities and our other listed alternatives, which means its addition to our portfolios can improve overall diversification. We also see some positive, long-term inflation-linked returns offered by the asset class in an investment landscape dominated by negative real yields.
More broadly, we continue to bake ESG considerations into portfolio construction, which includes establishing medium-term decarbonisation glide paths. In addition, we stress test our portfolios using LGIM’s proprietary climate-scenario analysis, to reveal which assets are most at risk or offer the most potential upside.
We are also moving the equity exposures in most of our funds from standard market cap-weighted indices to ESG-integrated indices – a shift of assets in excess of £10 billion – in addition to launching multi-asset strategies with explicit ESG objectives.
In our view, strategic thinking about ESG factors should focus on two elements: capitalising on opportunities provided by the paradigm shift in markets; and risk management by anticipating changes in how the market will price ESG risks in the future.
We believe the actions listed above demonstrate this thinking in practice and show our commitment to responsible investing as a way of effecting positive change across a range of ESG topics, not least the challenge of climate change, and delivering sustainable returns to our clients.