Sustainable, Responsible &/or ESG Policy:

We understand that different people have different opinions as to what is a sustainable investment. We therefore wanted to have clearly defined and measurable objectives for the portfolios.

With this in mind, the HSBC Global Sustainable Multi-Asset Portfolios aim to deliver:

• Globally diversified investment
• A higher average ESG score than the market
• A lower carbon intensity score than the market average

In addition to spreading risk across different asset classes and investment regions, we also increase exposure to companies and markets we believe are better positioned to deliver against long-term economic and societal requirements. We do this in two ways – by considering ESG factors along with greenhouse gas emissions (carbon intensity).

• ESG scores are a recognised way of measuring the level of sustainability in a company, market or investment fund. We use our insights along with independent research from multiple sources to evaluate ESG performance and sustainability qualities of the assets we invest in
• Looking at how much a company or market contributes to global carbon emissions relative to its size. To do this, we use independent data sources to measure a company’s greenhouse gas emissions

The aim of our multi-asset investment approach is to maximise investment returns in relation to the units of risk investors are accepting in their portfolios. In other words, we are aiming for attractive risk-adjusted returns, relative to a single asset class investment. This approach enables an investor to judge the degree to which they have been rewarded for taking risk.

We do not, therefore, measure the investment success of our portfolios against a formal benchmark, such as a global equity index. Instead, we consider the portfolios’ Sharpe ratios as good indicators of risk-adjusted performance.

The portfolios achieve broad asset diversification through exposure to the following asset classes:

• Global equities, developed and emerging markets
• Global government bonds
• Global corporate bonds
• Property (listed real estate securities)
• Cash

It is our belief that the overall asset allocation of a portfolio can only be robust when all portfolio components are considered sufficiently robust on a stand-alone basis. Therefore, all asset classes included in a portfolio’s investment universe must meet stringent selection criteria, such as sufficient liquidity, accessibility and contribution to overall portfolio diversification.

Asset classes have only been included where they can be fulfilled with an improved sustainability profile when compared to the market. Firstly, sustainability data for the asset class must be available. Then, the data must demonstrate favourable characteristics. It is important to note that this data is continuously evaluated and may be adjusted as the market evolves.

Process:

Our disciplined and active investment process is supported by global research and investment teams and is underpinned by a rigorous risk budgeting approach that combines asset allocation and portfolio construction to optimise return for a particular level of portfolio risk. Sustainability considerations are applied at all stages of portfolio construction.

We use a three-stage process for asset allocation:

• Stage1 - Long Term Positioning

Reference portfolios: articulation of risk profiles

The first step in building the Sustainable Portfolios’ asset allocation is creating a reference portfolio containing only

two assets (equity and government bonds) which reflects the risk tolerance of the portfolio.

While there are several methods of representing a portfolio’s risk tolerance (volatility bands, VaR metrics, maximum drawdown constraints), we use two asset reference portfolios given the following benefits:

• Portfolio weights provide a tangible and easy to understand representation of portfolio risk for end investors
• Comparison to other funds or benchmarks is clean and simple
• Reference portfolios are common structures in delegated institutional mandates such as pension funds or sovereign wealth funds
• These portfolios are independent of an individual’s view of prospective risk and return, meaning the portfolio shape should be relatively constant over time rather than changing to match volatility regimes/environments

It is also worth noting that the split between equity and bonds is the primary determinant of a multi-asset portfolio’s risk and return over the long run. A principal component analysis of a diversified multi-asset portfolio (please refer to the left-hand chart below) demonstrates that the two main factors driving portfolio returns explain about 85% of total variance. What is more, these two factors can be closely associated to the equity market risk and duration risk embedded within equity and bonds respectively. So, simply by knowing the approximate split of a portfolio into equity and bonds, we are able to understand most of what drives its long-term performance.

Equilibrium Strategic Asset Allocation: ultra-long term asset allocation

The reference portfolio is a useful starting point, and while the split between ‘risky’ and ‘safe’ assets is the primary determinant of overall performance, there are many time-varying elements which need to be taken into consideration outside of this simple decision. Therefore, the next step in deciding on the Sustainable Portfolios’ long-term positioning is to broaden the investment universe to include all investable asset classes.

The high-level allocations to equity and bonds are determined using our equilibrium expected returns (ultra-long term views of asset class properties calibrated using historical datasets). The equilibrium returns take into account over 100 years of asset class return and volatility data, in order to understand the very long run dynamics of asset class performance.

At the sub-asset class level, we tend toward market-capitalisation splits, adjusted for liquidity or other qualitative factors or client views.

This process results in the Equilibrium Strategic Asset Allocation (ESAA). The ESAA represents a view neutral portfolio, i.e. the optimal portfolio that an investor of a given risk tolerance should hold absent of any other market views.

• Stage 2: Dynamic Allocation Adjustments

Once we have decided on the Sustainable Portfolios’ long-term positioning, the second stage of portfolio construction involves making adjustments to the ESAA to account for the medium-term market dynamics, as well as shorter term opportunities.

While we expect our ESAA to deliver robust levels of return for the desired level of risk over the long term, in the medium term markets are inefficient, and in the short term we are able to take advantage of market dislocations, for example caused by political events, to add additional value.

Dynamic Strategic Asset Allocation

The Dynamic Strategic Asset Allocation (DSAA) builds on the ESAA by adding in our views on what asset class returns are going to be over the next 5-10 years (HSBC expected returns). These expected returns are created using our proprietary in-house framework, built on asset class valuations and taking into consideration the current macroeconomic environment.

For each asset class in the DSAA we develop three key data inputs: (i) expected returns, (ii) historic volatility and (iii) the covariance matrix. This data is used to conduct a Mean Variance Optimisation (MVO). We have developed a hierarchical approach to MVO which is detailed below and helps to overcome many of the well documented issues with a traditional MVO.

Expected returns

Asset class returns vary through time, particularly relative to each other. As a result, we advocate the use of forward-looking return estimates in addition to considerations of past asset class performance when calculating expected returns.

Our expected returns framework is built and maintained by HSBC’s Global Investment Strategy team, which creates expected returns for over 300 asset classes every month. The team employs a framework based on valuations, given the strong predictive power of current valuations on future performance: put simply, the price you pay for an asset today has a large effect on the prospective return of that asset. In addition to current valuations, our expected returns estimates take account of the prevailing macroeconomic environment as well as mean-reversion in risk valuations. The expected returns are calibrated over a 10-year forecast horizon.

Historic volatility

We compute volatilities of the relevant asset classes using at least 15 years’ worth of historic returns data at a monthly frequency. Asset class returns are not normally distributed but exhibit negative skewness (more extreme downsides than extreme upsides) and excess kurtosis (‘fat tails’). To account for this non-normal distribution in asset class returns we construct a more ‘robust’ estimate of volatility by incorporating higher moments (skew and kurtosis), using a Cornish-Fisher expansion methodology.

Covariance estimation

The covariance matrix plays a central role in MVO. In addition to excess skew and kurtosis, we know that outlier observations may have an outsized impact on the estimation of covariance. We therefore reduce outlier observations to levels which, whilst still exceptional, are not excessive.

Two Stage (Hierarchical) Optimisation within DSAA

Once we have all the necessary asset class data, we build the DSAA using a twostage MVO.

The first stage involves optimising a portfolio of two asset clusters: equities and bonds. Here we incorporate our view on risk and return as an aggregation of their respective sub-asset classes. Once we have determined the allocation to make to each headline asset cluster, the second stage is to then optimise within each headline asset group to determine the granular weights.

The intuition behind conducting the optimisation in two stages is simple: some asset class relationships matter more than others for the purposes of investment portfolios. For example, the relationship between equities and bonds is far more important for portfolio construction than that between Chinese equities and Russian equities. It therefore makes sense to deal with the most material asset class decisions first, before moving onto the more granular, and less consequential, allocations.

Additionally, by condensing the first stage to three assets, we have a simplified covariance matrix to invert, reducing the risk of corner solutions arising from its instability. Or expressed more simply, aggregating asset classes at the first stage stops any single sub-asset class from dominating in the optimisation and leads to more stable outcomes.

The result of the optimisation process is the DSAA, the portfolio structure for a given risk level. It represents the blend of assets that maximise expected return for the portfolios ex-ante volatility.

The portfolio management team conducts a qualitative ‘sense check’ of the output of the optimisation process. This can result in a re-running of the optimisation to achieve a sensible result and ensures the team do not blindly follow the quantitative process outlined previously. In general, the portfolio’s DSAA will be re-run every 6-12 months.

Inclusion of Alternatives

We believe alternative assets can play a key role in investment portfolios. However, we also recognise the significant differences between alternative and traditional asset classes, and the need for a distinct methodology for building them into the portfolios. Alternatives can be divided into two types:

• Diversifiers: uncorrelated to existing assets in the portfolio. Good examples are trend following strategies, long short risk premia strategies, gold and selective commodities
• Return enhancers: related to existing assets in the portfolio but improve return or reduce risk, usually by either adding a liquidity premium (private equity or direct real estate) or adding a complexity premium (selective corners of credit markets e.g. ABS)

• Stage3 – Portfolio Creation

Implementation of portfolio positioning

Having decided on the portfolio’s asset allocation, we must decide how the portfolio should be fulfilled. This is a trade-off between cost, efficient beta capture and an ability to add further value through the use of active management.  As such, the most appropriate fulfilment vehicle will vary from one asset class to the next.

We use active management in markets with inefficient benchmarks where there is large scope for alpha generation. Conversely, passive fulfilment is used to capture market beta while minimising costs in highly efficient and well covered markets. Finally, alternative weighting schemes are used where there is a wide body of literature demonstrating the existence of factor premia which can be harvested to add value.

Alternative weighting schemes provide an opportunity to diversify portfolio risks and also add value, while maintaining key asset exposures. For example, factor-based fulfilment choices such as equity styles have a role to play when implementing both dynamic and tactical positions. Dynamically, multi-factor equity portfolios act as a valuable diversifier to traditional market cap weighted vehicles, as well as potentially being a return enhancer over the long term. Additionally, tilting the factor exposure of equity within a portfolio is an effective way of expressing discretionary tactical views.

In general, we favour internal fulfilment given that we can access this at zero management fee, where possible, and have comprehensive oversight of the investment managers and their processes. However, in the situations where HSBC does not have an internal capability, that meets the requisite criteria for inclusion in our portfolios, we will use external providers.

Sustainability considerations are applied at all stages of portfolio construction.

As mentioned, we recognise the seven sustainable investment methods as set out by the Global Sustainable Investment Alliance (www.GSI-alliance.org).

All investment vehicles in the portfolios must follow at least one of these methods. For example, within the Sustainable Global Equity Fund (within which the portfolios are invested), both positive and negative screens are applied to investments in the portfolio. These screens are carried out using a “best-in-class” SRI screening approach, where companies are assessed based on a proprietary ESG research model. First, all controversial weapons companies are excluded.  The remaining companies are given an internal ESG rating (0-10) and are then divided into quartiles by sector. The 1st and 2nd quartiles are permissible investments, the 3rd quartile is limited to 15% of the final portfolio and 4th quartile is excluded.

The only two consistent negative screens across our entire investment range are that no fund should invest in banned weapons and tobacco. It is important to note that these are sustainable funds and we do not consider them to be ethical funds.

Resources, Affiliations & Corporate Strategies:

HSBC has several dedicated teams working together to deliver on our objective of being a leader in sustainable investing.

The Sustainability Office, led by Erin Leonard and who reports to CEO Nicolas Moreau, is responsible for the delivery of our sustainability business and product strategy, and the transition to sustainable investing across all parts of the business. The Sustainability Office also drives all of our people-focused initiatives such as Diversity, Equity & Inclusion (DE&I), as part of our focus on embedding a sustainability culture across the company.

The Responsible Investment team, led by Stuart Kirk and who reports to Global CIO Xavier Baraton, is responsible for the integration of ESG risks and opportunities across asset classes, as well as the overseeing the critical area of stewardship, which includes both voting and engagement globally, to ensure effectiveness in influencing the behaviours of the companies we invest in and in supporting companies in improving their practices. The team leads the development of new ESG, climate change and thematic products and solutions, the delivery of thematic research contributing to industry best practices and supporting thought leadership, as well as the use of structured and unstructured data to support the evaluation of ESG factors.

We also have a separate Stewardship team, with members based in London, Paris and Hong Kong, who work closely with investment managers when undertaking our stewardship activities; the reporting line is to the Global CIO. This team has grown in conjunction with our integration efforts, our understanding of the materiality of ESG issues on company returns and the increase in engagement on ESG issues. The team’s responsibilities include setting a global engagement plan, representing HSBC Asset Management on industry initiatives, leading collective engagements and working closely with our investment teams to support the integration of ESG factors into our investment processes by conducting thematic research, performing individual stock analysis and engaging with investee companies on ESG issues.

As part of our Responsible Investment Initiative, we aim to make responsible investing a front-of-mind topic for all HSBC Asset Management employees. As such we are incorporating sustainability KPIs in all employee scorecards and have developed a detailed training plan for all employees. We also provide educational opportunities for all employees on responsible investing, which include a series of inspirational talks on responsible investing-related topics catering for both beginner and advanced level knowledge. In 2020, we developed a customised ESG Investment Module in partnership with Principles for Responsible Investment (UNPRI) for our client-facing teams, and we also sponsor the CFA ESG Certificate for our investment teams.

HSBC Asset Management was an early PRI signatory in 2006. As a signatory of the PRI, we work with other investors in leading engagement on a range of issues. We report annually on our responsible investment activities and how UN PRI principles and different ESG aspects are covered as part of our investment processes. We achieved a PRI score of A+ in the 2018, 2019 and 2020 PRI Assessment Report for Strategy and Governance.

In 2010 we made the decision to move our dedicated ESG analysts into our mainstream equity and credit analyst teams in order to further integrate ESG into our mainstream investment processes. Since then, ESG assessments are a core responsibility of all of our portfolio managers and analysts. Our company and issuer level ESG research is undertaken throughout our organisation. We take into account all available company data including ESG factors when making investment decisions across all asset classes and strategies using in-house financial analysis, third party research and data as well as information gathered from company engagement. In addition to our own research we also use third party research and data from the following providers:

• MSCI ESG Research: Intangible Value ESG Assessment, comprehensive ESG assessment and Financial Crime Compliance screening. We use MSCI because their wide coverage of issuers and sector specific methodology
• ISS ESG (formerly ISS Ethix and ISS Oekom): Identifying issuers involved in the production and/or marketing of controversial banned weapons such as cluster munitions and landmine and government bonds' environmental and societal assessment. The specificity of our banned weapons definition can be implemented by ISS as one of the only providers covering government bonds
• Trucost Research: Quantitative environmental data to measure the carbon footprint of companies, issuers and our funds
• Sustainalytics: UNGC compliance and revenues from controversial and sustainable products and activities
• RepRisk: Tracking companies' reputational risk and involvement in ESG-related controversies (implementation in progress). Provides an ongoing view of issuer’s ESG performance, risks, and controversies
• FTSE Green Revenues: Provides revenues breakdown from green activity and its material impact on the bottom line for approximately 3,000 companies
• Carbon4Finance: Measures “carbon emission savings” to help understand a company’s strategic and financial commitment to a low-carbon transition

Collaborative Engagement

We focus on engagement with investee companies but also engage with stakeholders, regulators, industry partners and academics to inform standards and practices that will benefit the long-term interest of our clients.

A combination of the list below, together with local regulators and industry bodies and other institutions, provides an example of where HSBC Group and HSBC Asset Management have memberships and affiliations:

HSBC Asset Management

• UKSIF (the Sustainable and Finance association)
• AFG (Association Française de Gestion Financière) membre de la commission de Corporate Governance
• ORSE (Observatoire pour la Responsabilité Sociétale des Entreprises)
• ICGN (International Corporate Governance Network)
• Eurosif (the European Sustainable Investment Forum)
• FIR (Forum pour l’Investissement Responsable)
• Italian SIF (Italian Forum for Sustainable Finance)
• PRI (Principles for Responsible Investment)
• IIGCC (Institutional Investor Group on Climate Change)
• UK Stewardship Code
• ACGA (Asian Corporate Governance Association)
• Carbon Disclosure Project (CDP)
• Cambridge Institute of Sustainability leadership- ILG
• Council of Institutional Investors
• Global Climate Action 100+
• One Planet Asset Manager Initiative
• Finance for Biodiversity pledge

HSBC Group

• UN Environment Programme Finance Initiative (UNEPFI)
• UN Global Compact
• Wolfsberg Principles
• OECD Convention on Combating Bribery
• OECD Guidelines for Multinationals
• International Chamber of Commerce Rules of Conduct to Combat Extortion and Bribery
• Global Sullivan Principles
• UN Universal Declaration of Human Rights
• Equator Principles
• Roundtable on Sustainable Palm Oil
• Global Business Coalition on HIV/AIDS
• Carbon Disclosure Project (CDP)
• Extractive s/industries’ Transparency Initiative
• UN Principles for Sustainable Insurance
• Cambridge Institute of Sustainability leadership - ILG

SDR Labelling: Unlabelled with sustainable characteristics

• Consumer Facing Disclosure link