As sustainability continues to extend its influence across equity investment, we see considerable benefits of an ESG (environmental, social and governance)-based approach to fixed interest, potentially enhancing performance and reducing volatility.
Like other investors, we face the ongoing challenge that direct causation between ESG credentials and performance remains difficult to prove and this is especially true for fixed income. There are clear correlations, however, and we believe focusing on more sustainable parts of the market and avoiding companies and sectors challenged by environmental and societal considerations can drive performance. As evidence, we present the GF SF European Corporate Bond Fund, which celebrated its third anniversary on 29 May.
Highlighting our ESG credentials, the Fund has been awarded the Belgian Febelfin Towards Sustainability and French ISR labels, and is among the Liontrust funds classified as Article 9 under European Sustainable Finance Disclosure Regulation (SFDR) as sustainable investment is a major part of the investment objective. In addition, the Fund has a AAA ESG rating from MSCI, versus AA for the benchmark, and based on data from the end of 2020 (according to MSCI Carbon Analytics) portfolio holdings emitted 50.7% less than the benchmark.
Our philosophy is to identify mispriced ESG and sustainable risks as we seek to deliver strong risk-adjusted returns. Identifying these risks allows us to find high-quality sustainable companies where we can target undervalued credit and, when coupled with the dynamic nature of the Fund, this has allowed us to capture value from corporate bonds. We fundamentally believe sustainability analysis helps us to find undervalued credit, which in turn has led to the Fund generating over 400 basis points of alpha from corporate bond positioning, primarily across our favoured banks, insurers, and telecom sectors.
Since launch, we have been overweight credit and our belief is that underlying corporate fundamentals remain strong. Valuations are currently at five-year tight levels but we continue to see selective value in investment grade corporate bonds, as long as you have a dynamic enough mandate to capture opportunities. While fundamentals will likely suffer further after an extended period of lockdown restrictions, the re-opening of economies, supported by vaccine developments, will see an improvement in credit metrics, driven by a strong rebound in earnings from pent-up consumer demand. We expect companies’ focus to remain on improving these fundamentals, including creditor-friendly debt reduction and balance sheet repair.
On the technical side, a number of positive factors also persist, with central banks committed to loose monetary policy and ongoing corporate bond purchase programs, low supply given robust liquidity, extended fiscal support measures, and demand for corporate bonds as a rare source of yield for investors.
We also continue to believe government bond markets are significantly overvalued and maintain an underweight position to interest rate risk. With real yields deeply negative, our core view remains that it is prudent to stay underweight duration. We view inflation as being less transitory given unprecedented levels of pent-up demand, alongside ongoing supply constraints, and combined with the strong economic growth outlook, this also supports our preference to be short duration. Central bank rhetoric remains dovish to help contain government borrowing costs but this belies the underlying economic conditions, even after accounting for residual uncertainty. As such, we believe monetary policy will need to be tightened earlier than forecast to combat inflationary pressures and to be realigned with the economic outlook.
Looking forward, we are committed to our high-quality portfolio, which we believe is well positioned to withstand the economic impacts of the pandemic, and we do not view any of our holdings as exposed to a credit event. From a sector perspective, we continue to favour insurance, telecoms and banks, with cyclical non-financials generally over-owned, expensive and/or more heavily exposed to Covid-related uncertainty.
With insurance, for example, while it may not be the first sector that comes to mind when thinking about sustainability or positive ESG characteristics, the sector provides a number of benefits to society. It gives an economic safety net to millions, facilitates economic development and growth, and researches and furthers our knowledge of sustainability and key environmental and social issues. It is a sector that has robust fundamentals and strong solvency on average and, most importantly, continues to offer long-term value to bond investors, demanding its core position in the Fund.
Banks highlight the extra angle sustainable analysis can bring to bond investment. From an ESG perspective, our work on banks has traditionally focused on the governance element. In recent years, however, a growing number of banks have been looking to help facilitate the energy transition through a more aggressive and constructive approach to managing carbon within their corporate loan books and reallocating capital and funding away from carbon-intensive companies towards those actively seeking to address the climate crisis.
Given the shift within the sector, with many large-cap banks now looking to shape the energy transition, we aim to invest in those most committed to improving environmental exposure and demonstrating best practice to deliver on this. Factors for analysis include lending policies related to controversial sectors, lending to green projects and compliance with the Equator Principles for project financing. These are a financial industry benchmark for determining, assessing and managing environmental and social risk in projects.
Central banks are also pushing in this direction and this will likely serve to broaden and accelerate participation. The European Central Bank, for example, recently announced it is introducing climate-related stress tests (physical and transition risk) into its assessment of banks. Based on such developments, we have increased the relevance of how banks are managing the environmental impact of their loan books within our own methodology. As we move forward, we will engage further with laggards to try to effect positive change across the entire sector.
Discrete years' performance* (%), to previous quarter-end:
|
|
Mar-21 |
Mar-20 |
|
Liontrust GF Sustainable Future European Corporate Bond A5 Acc |
10.1 |
-4.6 |
|
Markit iBoxx Euro Corporates Index |
8.7 |
-3.4 |
*Source: FE Analytics, as at 31.03.21, primary share class, in euros, total return (net of fees and income reinvested). Discrete data is not available for five full 12-month periods due to the launch date of the portfolio.
Key Risks
