Alternatives, ESG and advice frameworks: 3 investment governance trends

This article discusses some trends in relation to investment governance by the wealth management and advice industries.

1. Liquidity is more important than ever; proceed with caution when it comes to alternative investments

Wealth managers have generally been well positioned during COVID-19 because of the investment governance processes that were put in place after the global financial crisis.

There were many lessons learned during the global financial crisis of 2007-08 (GFC), such as ensuring there’s no mismatch between the investment objective or risk profile of a fund, and the liquidity of the assets it holds.

Investment governance professionals undertake market and liquidity stress testing to understand which funds and asset classes on platforms may potentially be impacted by large redemptions or negative market movements in times of market stress. During COVID-19, the funds with larger drawdowns from within their asset class have mainly been in line with expectations based on previous market stress-testing exercises.

The performance of certain asset classes during the pandemic has served as a timely reminder to continue to be vigilant about ensuring there’s no liquidity mismatch. It’s critical to keep this in mind as we are seeing advisers’ and clients’ appetite for investments in the alternative space continue to grow.

We have observed far less “vanilla” fund additions from the traditional asset classes in recent times. Instead, new or boutique managers are investing in niche or hybrid asset classes, especially in the alternatives space, many with higher gearing levels. These include private equity funds that hold complex and illiquid assets, have more investment complexity and have a higher risk profile.

These trends have escalated significantly in the past 12 to 18 months, and are expected to continue at pace given the current outlook for rates.

Notably, less liquid investments can play an important role in portfolio diversification, especially when investing over the longer-term. What is key, though, is to ensure that the structure and redemption time frames of any fund holding these types of assets are appropriate.

2. We need to clarify what sustainable investing means

It’s essential for investors to understand what they are invested in; however, in the case of sustainable investing, the fluid definitions of commonly used terminology can obfuscate matters rather than providing much-needed clarity.

The sustainable investing boom has intensified in the past five years, resulting in more options and product information for advisers and investors to wade through.

According to Morningstar’s quarterly Sustainable Investment Landscape report, assets in Australian sustainable funds topped a record $25 billion in 2020. Fund flows proved resilient as market volatility eased during the pandemic. Furthermore, sustainable fund launches have been in the double digits since 2015.*

It is challenging for investors and advisers to navigate the volumes of information that abound in the market, partly because of the growth of sustainable investing, but also because there are still misconceptions about the terms used. Terms such as responsible/ethical/impact/green are used interchangeably, when in fact they are quite different things.

Wealth management platforms are in a unique position to help with sorting through the data.

One of our responsibilities as investment governance professionals (and in our role at BT as gatekeepers for wealth management platforms), is to ensure that funds stay true to how they are described. To this end, we have created a list of sustainable investment options that target companies with higher sustainability scores, or meet specific environmental or social goals.

Advisers using BT Panorama can access the list of sustainable investment options, which is based on a classification that considers quantitative and qualitative factors such as ESG ratings from external research houses, investment managers’ strategy and our own research. We also assess manager commitment to the implementation of sustainable investment or ESG policies and processes in portfolio construction.

3. Advice practices are finding tailored solutions to improve their own investment governance frameworks

As a platform provider, we are in a unique position to canvas what best practice looks like when it comes to investment governance by others in the industry, advice practices as well as investment managers.

It’s really pleasing to see the advice industry, whether they are boutique practices or large dealer groups, industrialising and professionalising the way they think about investment governance.

The take-up of managed accounts has shone a light on the capability of advice practices to manage investment governance processes that have traditionally been the domain of institutions.

Advice practices’ approach to investment governance varies widely; some have established expertise internally, while others outsource this function to external subject matter experts, as discussed recently at a BT roundtable.

For larger advice businesses that are relying on internal capability, operational considerations are leading to solutions such as the separation of the advice business from investments, by changing the corporate structure. While the upfront cost may be significant, the benefits from improved operational and risk management may be worth it. Allowing advisers to focus on client service and business development can result in improved business growth and increased profitability.

Investment governance may seemingly tick along quietly and reliably, but as these three trends indicate, it’s also a dynamic area that impacts businesses at their core and can provide powerful tools to help advisers educate clients about what they’re investing in.

Marnie McLaren, head of investment research and governance, BT