There is an ongoing debate about ‘values or value’, but investors can have both, explains Andrew Pitts.
Public pressure and rising regulatory burdens are leading asset managers to pay increasing attention these days to the environmental, social and governance (ESG) qualities of the financial assets they invest in, from equities to bonds.
For most it has been more of a tick-box exercise than a fundamental part of their investment process. But Covid-19, the climate emergency and new EU regulations, albeit indirectly, will bring the ‘E’ and ‘S’ aspects of ESG further into the spotlight.
The EU’s sustainable investing initiative is due to become law in the next few months and will be implemented in 2021. The specific rules on the marketing of financial products badged ‘sustainable’ have yet to be finalised, but it will aim to prevent so-called greenwashing – marketing a product as sustainable or green without any independent oversight to confirm the product does what it says on the tin.
This ‘green’ finance initiative, which is linked to the European Green Deal, is also aimed at helping companies seeking capital to make the transition to a zero-carbon economy.
Whether UK-based asset managers will follow the impending new EU rulebook on sustainable investing remains to be seen. However, it would be odd for major UK asset managers with important distribution channels in Europe, and vice versa, not to follow EU-mandated regulations, because they will want to ensure sustainable investment strategies can be sold to both EU and UK-based investors in a cost-effective manner.
Most people would empathise with the ethos behind the EU’s proposed rules, that sustainable investing is good for the environment, better for employees, and in the long run helps to underpin the generation of sustainable profits.
Several fund management groups have for several years been cognisant of this and have launched ranges of funds based on the concept of sustainable investing.
Stewart Investors, for example, was an early pioneer in the field, especially in Asia and emerging markets, although the sustainability theme has not recently paid off as spectacularly in these regions as it has in developed markets, particularly over the past three years.
Larger groups, including Aviva Investors and Henderson (now Janus Henderson), were also early adopters of SRI (sustainable and responsible investing) and each launched a suite of funds to satisfy demand, which was hitherto mainly from institutional investors. The F&C (now BMO) Stewardship and CIS (now Royal London) ranges of funds were popular with private investors.
Evidence that sustainable and/or ethical investing does not have to mean sacrificing values for value can be seen in this year’s fund awards. Outside?the ethical/SRI award categories, the 36 award recipients were identified from around 2,200 qualifiers. You might be surprised to learn that a quarter of those award-winners pursue ethical, sustainable and/or positive impact strategies.
Funds from the Royal London Sustainable range and Liontrust’s Sustainable Future range dominate, especially among mixed-asset funds. They are proving to be excellent choices for investors who are starting out, or for those who want a one-stop-shop for income or growth. And in one of the most important categories for UK investors – UK growth – Royal London Sustainable Leaders scoops the best larger fund award, while ASI UK Responsible Equity is highly commended in the smaller fund category.
In equity income, it is perhaps not surprising that Trojan Ethical Income and Janus Henderson UK Responsible Income grab top spots, given that they largely avoid companies that have been the most?prominent in cutting their dividends.
What is it these funds are doing that puts them head and shoulders above the crowd? Clearly, it has helped to have little exposure to the sorts of stocks that were hammered in the first three months of the year, such as energy, miners, airlines and, to a lesser extent, banks. But that only tells part of the story.
These funds have been focusing on a long-running theme: the structural shift to a more sustainable economy. For Peter Michaelis and Martyn Jones, two of the fund managers behind the Liontrust Sustainable Future range, this means “identifying and understanding the changes that will make the world cleaner, healthier and safer”.
They explain: “Our process is designed to highlight companies that will have been on the right side of this transition.” They add that companies they invest in have robust processes in place to manage customer relationships, employees and supply chains, as well as energy efficiency, waste reduction and material recycling. “We have long believed outperformance on these social and environmental issues will deliver more resilient businesses over the long term,” they state.
An associated idea within the sustainability theme is technology, and disruptive technology in particular. The Covid-19 pandemic has had a massive impact on growth expectations, but it is also likely to have a long-term impact on what constitutes a workplace for a swathe of the population. In this new economic paradigm, it is not surprising that investors now regard big tech as a defensive rather than an adventurous area to invest in.
In common with many other funds and strategies that come out of the Baillie Gifford investment partnership, disruptive technology and its applications are predominant themes, not only in the Scottish Mortgage and Edinburgh Worldwide investment trusts that it manages, but also in its Positive Change fund, which wins this year’s Best Larger Global Growth fund award.
Its global portfolio features some familiar US names among the top 10 holdings, such as Tesla, Alphabet and Illumina, plus Taiwan Semiconductor Manufacturing, but also chunky holdings in the less familiar. These include Denmark’s Chr Hansen, which manufactures natural ingredients in the bioscience field; Swedish sustainable heat pump manufacturer NIBE; and Japan’s M3, which provides medical-related services via the internet.
Will this fund and other sustainability-badged funds pass the EU’s tests? It will be months before the final ‘taxonomy’ of the new rules is announced. One reason for the delay is the need to clarify the blurred lines and differences between sustainable, responsible, impact and ethical investing. Meanwhile, ethical investors can assess the curated ACE 30* (avoids, considers or embraces) list of recommended ethical and sustainable investments from our sister website interactive investor, where several of Money Observer’s award-winning funds are also highlighted.
What of investment trusts that invest sustainably or ethically? There are none outside of highly focused themes such as renewable energy and environmental assets. Although several trusts do focus on investment ideas for the changing world, no trusts feature the words sustainable, responsible or ethical in their titles. Trust providers have not yet reacted to growing demand from investors who want profits with principles.
How the ethical award winners would look in a portfolio
To assess the returns that sustainable and ethical investing can generate across a range of asset classes, I combined all of the nine ‘sustainable’ award-winning funds from the non-ethical categories with the three winners from the ethical/SRI categories to see how their combined returns stacked up.
This equally weighted portfolio, which is 60% exposed to the UK, would have returned 14% and 33% over one and three years respectively, compared with a loss of -8% and -2% from the FTSE All-Share index.? But this ethical award winners’ portfolio also has around 20% exposure to bonds, so perhaps a fairer comparison is to compare the portfolio’s gains against the constituent funds’ own sector averages, which amount to gains of 1% and 7% over one and three years.
The heavy weighting of this notional portfolio to the UK is interesting, in that mega-cap technology stocks – a big contributor to strong returns from global sustainable funds in recent years – are mostly to be found in the US and Asia.
The funds here have negligible exposure to Asia and only 21% in North America. And despite the prospect of portfolio concentration due to overlapping strategies from funds managed by Royal London and Liontrust, only two companies have a higher than 1% weighting in the portfolio: AstraZeneca at 1.62% and Relx at 1.1%.
Despite the strong overall performance from this notional portfolio, it is also notable that two SRI funds in the UK equity income sector – although strong performers against their peers – actually lost ground over the past year.
This example is a crudely constructed portfolio, but a growth-oriented ethical portfolio that adheres to stricter asset allocation principles is provided by interactive investor.
You can find out more about it here: ii.co.uk/ethical-investing/
The award-winning profits and principles fund portfolio
|?||?||% return and sector
quartile ranking after:
|Award-winning fund||IA sector||6 mths||Rk||1 yr||Rk||3 yrs||Rk||5 yrs||Rk|
|ASI UK Responsible Equity||UK all companies||-4.4||1||3.3||1||18.2||1||41.0||1|
|Baillie Gifford Positive Change||Global||32.0||1||47.5||1||97.9||1||?||?|
|Janus Henderson UK Responsible Inc||UK equity income||-8.5||1||-2.1||1||2.1||1||16.3||1|
|Liontrust Sust Future Defensive Mngd||Mixed inv 20-60% shares||4.9||1||8.7||1||22.6||1||43.2||1|
|Liontrust Sust Future Global Growth||Global||15.9||1||23.2||1||59.6||1||104.0||1|
|Liontrust Sust Future Managed||Mixed inv 40-85% shares||10.1||1||15.6||1||40.5||1||70.6||1|
|Rathbone Ethical Bond||￡ corporate bond||1.3||3||6.1||2||14.2||1||30.8||1|
|Royal London Ethical Bond||￡ strategic bond||1.3||2||5.3||2||12.4||1||28.6||1|
|Royal London Sust Diversified||Mixed inv 20-60% shares||6.6||1||12.8||1||28.0||1||58.9||1|
|Royal London Sust Leaders||UK all companies||2.1||1||9.9||1||29.1||1||60.7||1|
|Royal London Sust World||Mixed inv 40-85% shares||11.1||1||18.6||1||43.4||1||91.9||1|
|Trojan Ethical Income*||Unclassified||-5.0||?||-0.6||?||13.6||?||?||?|
|FTSE All-Share index||?||-9.6||?||-7.5||?||-1.7||?||?||?|
Notes: *No sector rank is given for Trojan Ethical Income, as funds in the unclassified sector are highly diverse. Portfolio return is with holdings equally weighted. Source: FE Analytics, as at 8 June 2020; performance with income reinvested.
The author was editor of Money Observer from 1998?to 2015.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.