Market study and asset allocation

has an importance of 6.5 out of 10 compared to 6.8 globally. Also, “positive impact on local social outcomes” gets the score of 6.4 against 6.7. Similar comparisons can be done for the other categories (good corporate governance, a good record of social responsibility and a positive impact on worldwide social outcomes) (Schroders, 2016). It is also interesting to notice the disparities within Europe itself. As an example, Italians, according to this study seem more sensitive to the positive environmental impact of their investments (7.1/10) than Dutch (5.9/10).

The Netherlands’ score on this topic is notably surprising as it is one of the most threatened European countries by climate change and sea level rise.

Investors’ sensitivity towards ESG issues keeps on increasing these past years. The most ESG-oriented investors are the millennials. Indeed, the younger is an investor, the more chances he has to be willing to invest in social and responsible assets (Schroders, 2016). And this is good news as in Europe, the SRI market is on an upward trend. However, in the past and still in most cases nowadays, a global offer has been provided to individuals who often do not match their specific concerns. But diversified sustainability themes options start to be offered to investors to meet their different interests, making the SRI market grow. Apart from ESG issues, the asset classes in which people want to invest also vary from one to another and need to be considerate by asset managers while building portfolios.

2.2.2. Market study and asset allocation

In 2017, the European Commission alerted the European Union members about the investment gap between the level of investment needed to meet the Paris Agreement targets and reality.

This gap is estimated at around €180Bn of additional investments every year until 2030 (Eurosif, 2018). Even though institutions represent the largest part of the SRI, the portion of individual

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represented only 3.4% of the total SRI asset value against 30.8% in 2017. Retail investors find some advantages and disadvantages following SRI strategies (Eurosif, 2018). Financial opportunity, concerns about ESG issues, contribution to local communities, long-term and stable returns are various drivers mentioned in almost equal proportions by investors. Mistrust about greenwashing followed by the lack of viable options and qualified expertise are the main concerns about sustainable investment. Interestingly, risk management is both perceived as a driver and a threat. But the threat may come from the skepticism of asset managers honesty in general rather than SRI asset managers in particular. In all cases, individuals’ share of total SRI asset value could keep on rising. Indeed, the “mythic” negative trade-off with returns present in the collective consciousness has been overturned by several recent studies (Ibunkele, 2017).

In some cases, the green and the social investment could even outperform their systemic counterparts.

SRI investment options are divided in several asset classes: equity (46.45%), bonds (40%), monetary/deposits (2.59%) and other (10.96%) (Eurosif, 2018). The following section will provide some financial definitions essential for the understanding of this thesis. Equity defines the company’s value. It is the difference between its assets and its debts. In investment, equity refers to corporations’ stocks. Thus, stocks are shares of a company’s wealth and their value depict what shareholders would get if the firm was liquidated. Bonds are part of the fixed income instruments. They are loans issued by entities such as corporations, governments, municipalities and supranational organizations bought by investors called bondholders.

Supranational organizations are international groups in which authority goes beyond boundaries (Investopedia, 2019). In the case of SRI, a majority of the bonds come from corporations (60%) while 33% are issued by the government (Eurosif, 2018). They are called sovereign bonds. The

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last 10% is split between municipal bonds and supranational bonds. Monetary and deposits also named cash and cash equivalents in a balance sheet, are liquid instruments like cash and deposits held in any financial institution. A new sort of “cash” instrument recently appeared on the investment horizon; cryptocurrencies. Therefore, its belonging to cash and cash equivalents class is discussed by many economic experts. Stocks, bonds and money market instruments can be components of mutual funds which are the most common investment vehicle for small investors. Money managers who operate mutual funds purchase a vast number of securities from different asset classes and various industries. Mutual funds are usually considered as one of the best options for enjoying the diversification effect and mitigating risks for retail investors (Investopedia, 2019). Indeed, mutual funds do not necessarily require to be extremely wealthy compared to other investment options such as commercial papers which are usually issued in multiples of $100,000.

In the context of sustainable investment, SRI mutual funds have especially received interest from the financial research community. In Europe, SRI mutual funds do not outperform their conventional peers while using the best-in-class strategy (Cortez, 2014). Also, some critics were formulated about this strategy as even though it increases the diversification effect that sometimes SRI mutual funds lack, it can be controversial to use it as a “SRI” strategy. Indeed, in the best-in-class strategy, the companies with the best ESG score in each industry are selected rather or not this score is really high. This means that a company which belongs to a questionable sector but has a “less bad” impact than its competitors, could be included in a SRI mutual fund. For instance, green mutual funds, a subset of SRI funds seem to be affected by the lack of diversification of the industries’ sectors in which they are represented. Comparative analysis performed between black mutual funds (fossil energies) and green mutual funds, from

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1991 to 2014 shows a performance decrease of the first ones and increase of the second ones over time (Ibunkele, 2017). This may be due to political and social pressure on environmental issues. Another significant finding is the underestimation, in the case of black mutual funds and overestimation, in the case of green mutual funds of risks. This incorrect assessment of risks has a direct impact on the level of demand of these funds and hence, their prices.

Predicting risks and returns are the main missions of an asset manager according to the optimal portfolio theory. Choosing which assets can create the optimal portfolio that differs from an individual to another relies on two central parameters: the investor’s level of risk aversion and the amount he wants to invest. The first parameter is a vital measure of the asset allocation process. Indeed, each individual has a different degree of risk tolerance that allows him to expect a certain level of return. The second parameter as we mentioned previously is essential to get the opportunity or not of investing in some assets. As evoked previously, small investors may encounter entry barriers while wishing to purchase some assets due to their wealth. Hence, balancing risk and reward and reaching the level asked by investors is the most complicated challenge of asset managers. Nowadays, in many cases, a new parameter, ESG, needs to be included in the balance making managers feel like the equilibrium they try to reach is even less stable than before. Nevertheless, rather than a risk, sustainable investing should be and begin to be considered as an opportunity. Europe has the chance to make a drastic and much-needed change to let the future generations have a future. And this will not be done without a change from traditional to sustainable investment.

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