Overcoming the challenges of responsible investing in a low return environment
Knut Kjær, founding CEO of Norges Bank Investment Management and Chairman of FSN Capital talks to RAOGlobal about the challenges of responsible investing in a low return environment. Knut will be addressing these issues and more at the Responsible Asset Owners Global Symposium in London 2019.
Q. Will managing climate related risks and opportunities in investments enhance investment decision making and better inform Asset Owners of their priorities?
A. Yes, definitively. All investment decision making is about managing risk. Expected returns must be measured against expected risk. Long-term climate risk is probably the most important one facing investors. It includes lots of uncertainty and is complex to deal with. But investors must face it. Learning about possible consequences and devising scenarios improves the investment process.
Q. Can such a framework reinforce long term value creation, improve risk return profile and long term portfolio resilience?
Yes! It is all about managing risk; climate risk, social and governance criteria are all obvious parts of risk assessments. We need to think beyond just the financial dimensions. The longer the investment horizon the more important the extension of risk analysis.
Q. What in your opinion are the most frequent mistake investors make?
A. The number one mistake is procyclicality – lacking ability to stay rational during a cycle. It happens to investors who overstretch their risk taking (compensating for lower expected return by taking up portfolio risk) and investors with a poor quality governance structure. The latter is lack of principal and agent alignment. Being successful requires skill!
Q. Given the current uncertainty in the geopolitical landscape what are the three most important factors investors need to consider when creating more robust portfolios?
A. There have always been geopolitical risks. History has taught us that events only have a short term effect on returns. Assets bear risk premiums due to uncertainty – that’s good for long-term investors!
1. The entering portfolio risk level: Are we prepared for the next financial market meltdown and the possibility for a lasting lower level of asset prices (not just a normal mean reversion cycle)?
2. Is the portfolio sufficiently diversified? Investors need to understand the factor exposure of the portfolio and sort out in advance what could be common factors driving return during the next downturn.
3. Is the governance structure and decision making framework sufficiently strong to ensure rational response in a market crisis scenario? And is the risk taking sufficiently anchored by the owner of the risk, are there formal rebalancing rules?
Edited by Oonagh McQuillan 7 September 2018