ESG Megatrends: Implications for Strategic Asset Allocation

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Environmental, social and governance (ESG) factors can affect each security in specific ways, by increasing risks or creating opportunities. Most of these factors are part of broad trends currently affecting the economy. These ESG megatrends can have consequences for institutional investors at a strategic asset allocation (SAA) level. In a series of papers, we identify a global, ESG macro trends, which we call megatrends, and investigate how they could affect strategic asset allocation decisions and portfolio risk-return profiles.

ESG and the economy

As we've witnessed in the first half of 2020, structural economic changes and macro-level events have roots in ESG factors. From pandemics and environmental degradation to social unrest, ESG issues have shown their potential impact on the global economic situation. While it is increasingly common to factor such ESG concerns into the security selection process, ESG integration within a strategic asset allocation framework seems less prevalent.

We believe awareness of ESG megatrends may enhance institutional investors' decision making. Understanding long-term, global systemic risks can help inform investment decision-making today to help mitigate risks in the future. In this series, we explain the role of ESG integration in the strategic asset allocation process. Our views are based on recent studies identifying ESG trends that are expected to shape society for the next decades. We identify 16 ESG megatrends within six key categories.

Source: Aegon Asset Management, April 2020.

ESG megatrends

Not all megatrends may be directly relevant for investors' portfolios or for the economic indicators that shape it. To focus our research efforts on the trends that are likely to be most material, we use a score-based framework to estimate a trend's potential direct effect on certain asset classes or macroeconomic variables, its timeframe as well as the potential intensity of its effects and probability of occurrence. We assign scores on each of these dimensions based on existing research from academia and practitioners. This leads us to conclude that five ESG megatrends are most material to the world economy, and therefore, more likely to affect investors' portfolios:

  • Extreme weather events arising from the physical effects of climate change
  • Risks and opportunities linked to the transition to a net-zero carbon economy
  • Changes in the labor market due to increasing automation and artificial intelligence
  • Demographic trends and the impact of population aging on labor markets and interest rates
  • The increased risk of pandemics

Integrating ESG megatrends within SAA

For example, demographic trends will likely put a strain on public finance, tighten job markets and put downward pressure on interest rates. Meanwhile, transition risks arise from the actions taken to mitigate climate change which could potentially lead to higher prices for emitting greenhouse gases. These sorts of trends could have various financial consequences. This, in turn, may affect risks and returns across many asset classes. As a result, we believe integrating ESG megatrends when setting SAA could improve the resilience of portfolios.

Scenario analysis

To translate the trends into our strategic asset allocation, we use scenario analysis. Scenario analysis can help us to quantify the potential impact of ESG megatrends on the portfolio of institutional investors. This also enables us to test the consequences of adjusting on the probability of meeting the investor's objectives and goals as ESG megatrends evolve. We begin by uncovering the driving forces behind these trends and the implications for macroeconomic variables. This generates asset class return assumptions for different scenarios. We can then use these to test whether a portfolio is prepared to withstand those effects, and how to best adapt it to the changing world economy.

Disclosures

This material is provided by Aegon Asset Management (Aegon AM) as general information and is intended exclusively for institutional and wholesale investors, as well as professional clients (as defined by local laws and regulation) and other Aegon AM stakeholders.

This document is for informational purposes only in connection with the marketing and advertising of products and services, and is not investment research, advice or a recommendation. It shall not constitute an offer to sell or the solicitation to buy any investment nor shall any offer of products or services be made to any person in any jurisdiction where unlawful or unauthorized. Any opinions, estimates, or forecasts expressed are the current views of the author(s) at the time of publication and are subject to change without notice. The research taken into account in this document may or may not have been used for or be consistent with all Aegon Asset Management investment strategies. References to securities, asset classes and financial markets are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions.

The information contained in this material does not take into account any investor's investment objectives, particular needs, or financial situation. It should not be considered a comprehensive statement on any matter and should not be relied upon as such. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to any particular  investor. Reliance upon information in this material is at the sole discretion of the recipient. Investors should consult their investment professional prior to making an investment decision. Aegon Asset Management is under no obligation, expressed or implied, to update the information contained herein. Neither Aegon Asset Management nor any of its affiliated entities are undertaking to provide impartial investment advice or give advice in a fiduciary capacity for purposes of any applicable US federal or state law or regulation. By receiving this communication, you agree with the intended purpose described above.

The sample pension fund analysis is intended to demonstrate a potential outcome of Aegon Asset Management's ESG assessment. Like any analytical tool, this analysis may be useful in identifying potential portfolio strategies, it is not intended to represent any individual investors portfolio results and is not a prediction of actual results. Investors should consult their investment professional prior to making an investment decision.

Strategies are supported in part by investment models and/ or other analytical tools. These models or tools inform but do not dictate investment recommendations. There is no assurance that these models or tools will work as intended, produce accurate results, or be free from defects, all of which could impact investment performance. Models or tools may be discontinued or modified for any reason and without notice.

Past performance is not a guide to future performance. All investments contain risk and may lose value. Responsible investing is qualitative and subjective by nature, and there is no guarantee that the criteria utilized, or judgement exercised, by any company of Aegon Asset Management will reflect the beliefs or values of any one particular investor. Responsible investing norms differ by region. There is no assurance that the responsible investing strategy and techniques employed will be successful. Investors should consult their investment professional prior to making an investment decision.

Results for certain charts and graphs are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions. 

This document contains "forward-looking statements" which are based on Aegon AM's beliefs, as well as on a number of assumptions concerning future events, based on information currently available. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance, and actual outcomes and returns may differ
materially from statements set forth herein.

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Simon Lambert

About Simon Lambert

Responsible Investment Associate

Gertjan Medendorp

About Gertjan Medendorp

Senior Investment Strategist Fiduciary Services & Investment Solutions