From index tracker to conscious investor: the equity portfolio in 3D

Together with our client PFZW, we aim to build an investment portfolio that delivers market-level returns, operates within acceptable risk, and achieves a relatively high level of sustainability. Following Credit, Equities are the next area where this integrated vision has been applied. In this article I explain how we have put this into practice. 

From ambition to execution
The redesign of the Equities portfolio started with PFZW’s updated investment beliefs in 2022, which established that return, risk and sustainability should be given equal weight. This three-dimensional (3D) approach requires deliberate choices: which investments contribute to solid returns, remain within the risk budget, and improve the portfolio’s sustainability profile? 

To gain this insight, we first defined our main objectives and parameters, including the risk budget and required liquidity. We then invited several external parties and our internal investment teams to develop prototypes. This gave us a clear view of potential strategies, the limits of what is achievable, and the trade-offs required to achieve our objectives. 

Two complementary strategies
For the Equities portfolio, we ultimately chose to combine two complementary investment strategies to achieve our goals: fundamental and systematic. 

Fundamental managers focus on in-depth analysis and gaining a genuine understanding of the companies we invest in. Sustainability is complex; data is essential, but context is just as important. Our guiding principle is to ‘know what you own’. This allows us to make more informed choices, such as selecting companies that are leading the energy transition or those that are not yet at the forefront but are taking credible steps forward, the so-called ‘improvers’. 

However, a purely fundamental approach has its limits. You can only follow a limited number of companies closely, which reduces the size of the investable universe. For this reason we complement it with systematic strategies. Using quantitative models, we screen the entire investment universe, incorporating sustainability scores as part of the process. This enables broader diversification, stronger risk control and effective liquidity management within the portfolio. 

Combining these two approaches gives us the best of both worlds: depth and scale, deliberate selection and broad diversification. 

From passive tracking to active construction
Moving towards a 3D approach also means leaving behind our former passive strategy. Previously, we largely followed an index containing thousands of companies. As a result, we were occasionally confronted with unwelcome surprises when incidents occurred at companies in our portfolio simply because they were part of the index. 

Now we have reversed the process: the benchmark is no longer the starting point but instead serves as a reference after construction. This approach is what we refer to as conscious investing. We build the portfolio deliberately, focusing on balancing return, risk and sustainability. 

In practice, this means we are reducing the number of holdings from around 3,500 to approximately 800 companies. We are taking on slightly more active risk, with tracking error increasing from 1% to 1.25%, but this is a conscious decision aimed at making the portfolio more sustainable and resilient. 

Measurable sustainability improvements
This renewed investment approach delivers directly measurable results. For instance, the portfolio’s SDI alignment improves further from 19% to around 21% (versus 12% for the market index), while our Paris alignment score increases from 23% to 30% (versus 18 for the market index). Carbon intensity, which we were already managing closely, decreases even further, from 86 to 73 (versus 249 for the market index). 

At the same time, we recognise that not every individual holding needs to achieve top sustainability scores. We set a clear minimum standard and apply strict inclusion criteria to ensure the portfolio as a whole is materially more sustainable than the broader market, while still delivering market-level returns. 

Equally important is allowing room for improvers, companies that are not yet leading but are demonstrably willing and able to improve. In doing so, we aim to contribute to real-world impact while making the portfolio more resilient and better positioned for the future. 

Strong partners with shared values
Manager selection plays a critical role alongside portfolio construction. We deliberately seek asset managers who are not only financially strong but who also share our sustainability ambitions. Stewardship is another key focus: do managers actively encourage portfolio companies to become more sustainable through engagement and voting? While we maintain our own voting policy, we want our partners to be as closely aligned with us as possible. 

This sometimes requires pioneering work, as not all asset managers - particularly in the United States - share the same perspective. Nevertheless, we are seeing growing enthusiasm among many parties, who are eager to work with us to lead the way. 

Prepared for the transitions ahead 
With this renewed Equities portfolio, our aim as an asset manager is to contribute to robust pensions while supporting the major societal transitions of our time, such as the energy transition, the food transition and other large-scale transformations. As a long-term investor, we need to build a portfolio capable of withstanding a range of future scenarios. In doing so, we help ensure good pensions for the participants while positioning the portfolio for the challenges and opportunities that lie ahead.