The benefits of ESG within individual investment options

The current climate calls for a nimble and intuitive approach. Liechtenstein-based Kaiser Partner offers its own holistic take on investment strategies

Vaduz, Liechtenstein, home of Kaiser Partner Privatbank AG
Vaduz, Liechtenstein, home of Kaiser Partner Privatbank AG 

Today’s world is one of increasing transparency and accountability plus social and environmental consciousness. We at Kaiser Partner Privatbank AG are more aware than ever of the heightened effect our actions – and investments – will have on employment, food and clean water supplies, social order, health, and education, both for those around us, and the generations after us. Since signing the UN PRI more than a decade ago, we have continued to incorporate ESG issues throughout our investment process.

Today, we offer a holistic approach for sustainable investment solutions that reflects client-specific goals and values. We will look at tailor-made solutions based on client preferences. In addition, we carefully monitor our ESG practices with regard to controversies, impact measurement and business involvement to ensure we meet our own high standards at all times.

Throughout its history, the principality of Liechtenstein has always stood for innovation, liberty and entrepreneurship

Our responsible investment offering covers all aspects of the investment chain – starting from a value-based onboarding process through to a comprehensive report disclosing the portfolio’s carbon footprint, its ESG rating distribution and to what degree the client’s personal portfolio contributes to achieving sustainable development goals.

When investing responsibly, our mission is to deliver competitive financial returns by mitigating the risks associated with ESG factors to protect value in the long-term. In doing so, our approach is fluid rather than dogmatic, taking into account traditional risk and return figures, and allowing us to manage portfolios that are sustainable while focusing on strong risk-adjusted performance.

In our view, ESG considerations can be incorporated without overly limiting individual investment options or how these options perform. In this sense, we are committed to an active ownership approach – meaning that we will engage constructively with companies and public policy rather than choosing ‘easy’ options like divestments or greenwashing. This fluid approach, with concomitant emphasis on providing innovative and tailor-made solutions, leaves us well placed to adapt not only to the priorities inherent in responsible investing, but also to be dynamic in the event of shifting market tectonics.


Adapting to negative interest rates
Times have changed, and for a growing number of investors, negative interest rates are becoming a real challenge as more and more banks in European countries are charging their clients interest on cash balances – starting from ever lower levels. This issue is especially prevalent with small to medium-sized companies, which usually carry relatively large cash positions of several million euros just to be able to act quickly when business opportunities arise – or simply preparing for unforeseen cash outlays. For clients like these, we offer an attractive solution.

Instead of holding large cash positions with a bank and paying negative interest rates, our clients can invest in a minimum volatility portfolio that yields an estimated 1.5 percent annual return while keeping drawdowns at a minimum. If short-term liquidity needs arise, instead of selling some assets we offer the client a Lombard loan collateralised by the securities in the minimum volatility portfolio. This way, they only have to pay interest when liquidity is actually needed, while always being invested in a liquid solution with the cash portion that would otherwise be subject to negative interest rates.

But it is not only negative interest rates set by the SNB and ECB that pose challenges. We also have to contend with the wider implications of the ‘lower for longer’ interest rate environment – resulting from a decade of expansionary monetary policy globally, and especially in Europe. As a result, government bond yields are negative in Switzerland and Germany; and even Italy – with its huge debt burden – can refinance at extremely cheap prices.

For an investor, there is not much to gain from safe bonds as they will often lock in a guaranteed negative return if they hold these securities until maturity. Not only are bonds with high credit quality zero-yielding assets, but they are also an increasing risk to investors’ portfolios as the potential for price increases is very limited while the downside – in the case of a rising interest rate environment – is huge. And while high-quality bonds have traditionally acted as a form of portfolio insurance – as they often cushioned stock price drawdowns in the past – this kind of hedging behaviour looks questionable going forward.

The corona crash in spring 2020, during which government bonds didn’t help much in stabilising a balanced portfolio, was a reminder that the good old days of the 60/40 portfolio may be over – both in terms of absolute performance and risk characteristics. Investors looking for good risk-adjusted returns in the future will have to show a bit more creativity, particularly when configuring the fixed-income part of an investment portfolio.

The demands on this safe portfolio component remain the same as before – it should earn a solid minimum return, and its correlation to stocks should be relatively low so that the overall portfolio stays stable during periods of crisis.


Sound investment alternatives
Inflation-protected bonds, insurance-linked bonds (catastrophe or ‘cat’ bonds) and microfinance bonds are asset classes that particularly meet the above requirements, in our view. Adding these interest-bearing alternatives to conventional government and corporate bonds, as well as high-yield and emerging-market bonds, and combining these fixed-income components with stocks to build a balanced portfolio allows us to continue generating attractive future returns.

The average annual expected return for our optimised (and diversified) investment portfolio stands at plus 4.7 percent for the next five years, according to our calculations, entailing slightly less risk when compared to a simple portfolio consisting of 50 percent bonds and 50 percent equities (expected to return only 3.4 percent). This clearly shows that a strategic asset allocation, which we review on an annual basis, adds value for our clients and reflects our mantra ‘Responsibility in Wealth.’

However, there’s no such thing as a free lunch. If you integrate interest-bearing alternatives into a portfolio, you get similarly good diversification properties and a better return than with conventional bonds, but the liquidity properties will not be as good. But since a balanced portfolio typically has a three-to five-year investment horizon, this ‘liquidity premium’ is acceptable. Investors should generally move away from the idea of maintaining daily liquidity for their long-term fixed-income investments or should at least be aware of the opportunity costs of doing so.


A positive five-year outlook
Today, almost every asset category that could be deemed ‘traditional’ is over-valued and yields on safe interest-bearing securities are ultralow – or even negative – due to years of ongoing inventiveness on the part of central banks. Hence, financial market participants should expect lower returns, especially from the traditional asset classes, namely bonds and equities. The formulation of capital market expectations is one of the key components of our annual strategic portfolio review.

This process ensures that the client assets under our management are constantly invested in line with a forward-looking, sustainable strategic asset allocation (SAA) in lockstep with the times. Our annual review process covers a number of elements – among them the determination of the relevant asset classes and the time horizon, for which return expectations are to be formulated. We focus here on a medium to long-term period of five years, allowing us to take longer-term valuation anomalies into account and at the same time take into account current micro and macroeconomic trends.

Next, a sound model is developed for each asset class and sub-category to derive five-year return expectations. The stability of the estimated parameters is a crucial cornerstone for later mean-variance optimisation. We therefore use a combination of multiple models wherever possible to derive return estimates in order to obtain results that are as broad-based as possible.

A number of ingredients come into play here. For government and corporate bonds, the starting yield explains a very high portion of the expected five-year return and is hence a key input to our assumptions. As for equities, we combine three different models: equity risk premium, a sector-based approach and historical equity returns for different regions.

Capital market investments over the next five years will involve fewer classic instruments in the portfolio – or feature alternative ones (see Fig 1). Equities continue to be the asset class with the highest expected returns, but with estimates of around five percent for US equities, as an example, these are clearly lower than what investors were able to earn in the last decade.



Our results also show that alternative asset classes like hedge funds and private equity will have to play a larger role in an investor’s asset allocation going forward if the aim is to generate a decent return in the next five to 10 years. The same applies to fixed-income alternatives like insurance-linked bonds, microfinance and other more innovative instruments like peer-to-peer lending. Investors will have to increase their allocation of these alternatives while reducing their exposure to the more classic fixed-income instruments like government and corporate bonds – where return expectations are around one percent in the US – and lower still, close to zero, even, in Europe and Switzerland.


Strategic location
Kaiser Partner Privatbank’s base in Liechtenstein comes with many benefits. This tiny country in the heart of Europe is the epitome of political continuity and stability. The principality boasts a triple-A sovereign credit rating and is debt-free. Moreover, it combines the best of two worlds – Liechtenstein is tied to Switzerland through a customs and monetary union and has direct access to both the European Economic Area (EEA) and Switzerland. This unique combination facilitates attractive growth prospects in many sectors including the financial services industry.

Throughout its history, the principality of Liechtenstein has always stood for innovation, liberty and entrepreneurship – and the same could be said for the family-owned Kaiser Partner Privatbank AG.