GLOBAL - Sustainable investment strategies improve the risk/return profile of portfolios, according to a study by risklab, a subsidiary of Allianz Global Investors.

The study, called 'Responsible Investing reloaded - Sustainability criteria matter', says environmental, social and governance (ESG) criteria should be an integral part of the investment-making decision process to minimise tail risks.

Risklab director Steffen Hörter said: "In today's capital market environment, investors increasingly diversify away from low interest paying government bonds to more profitable assets such as emerging market equities or corporate bonds in order to meet their return targets.

"Our analysis shows the tail risks of these asset classes can be significantly improved when ESG criteria are taken into account."

The average tail risk for emerging market equities, which is measured according to conditional value at risk (CVaR 95%), can be reduced from -64.5% to -38.8% a year if ESG criteria are taken into account, according to the study, which compared an ESG-optimised portfolio with the MSCI Emerging Markets index.

The average tail risk for corporate bonds was reduced from -8.1% to -4.9% per year when comparing the ESG-optimised portfolio with the Merrill Lynch Global Broad Market Corporate index.

Furthermore, ESG criteria are also important for core asset classes such as developed markets equity, where the risk could be cut from -38.1% to -25.7%, compared with the MSCI World Equity index.

Differences were even bigger in all three asset classes if the respective benchmarks were compared with portfolios that had a strongly increased ESG risk exposure.

Risklab analysed a balanced portfolio of 50% equities and 50% bonds over a period of 20 years. The reference portfolio generated an annual return of 6.5%, with an average tail risk of -15.9%.

In comparison, it found that the two ESG-risk optimised portfolios either saw their risk fall to -10.9% with the same return or, while holding onto the same tail risk, generated a return of 7% per year.