Aitken Ross

The ESG effect in bond markets

Aitken Ross

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As sustainability continues to extend its influence across equity investment, we also see considerable benefits to an ESG-based approach to fixed interest, potentially enhancing performance and reducing volatility.

Like all managers in this space, 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 as stated, we believe focusing on more sustainable parts of the market and avoiding companies and sectors challenged by environmental and societal considerations can drive performance: not only do sustainable companies typically have better growth potential, they are also more resilient than the market thinks. As exhibit one, we present our SF Corporate Bond Fund, which is currently top quartile over one, three and five years, and since the current team has been at the helm from August 2012.

Performance of SF Corporate Bond Fund (%)*:

 

 

One year

Three years

Five years

Manager inception

Liontrust Sustainable Future
Corporate Bond 2 Inc

11.8

15.4

28.3

51.4

iBoxx Sterling Corporate
All Maturities Index

11.0

14.0

28.2

53.3

IA Sterling Corporate Bond sector

9.5

12.5

22.4

41.4

Quartile

1

1

1

1

*Source: Financial Express, as at 31.12.19, primary share class, total return, net of fees and interest reinvested. The current fund management team took over responsibility of the Fund on 20.08.12

 

At its core, our process looks to invest in businesses providing solutions to the world’s problems and coupling this with strong credit fundamentals and, most importantly, attractive valuations. Combining all three elements, sustainability, value and fundamentals, has helped steer us through volatile markets and deliver returns to clients.

 

For us, industries and sectors that damage society and the environment are susceptible to either enforced regulatory change and/or evolving consumer habits, both of which can be detrimental to long-term returns. In the SF Corporate Bond portfolio, we have never had exposure to oil, coal, mining, autos (internal combustion engine), nuclear or tobacco, to name a few – and these sectors have not only underperformed on the whole but done so with considerable volatility.

 

Moving to sectors where we do find opportunities, within banks for example, our process leads us to favour institutions that predominately generate revenues from retail and commercial banking operations as opposed to investment banking activities.

 

In addition to believing the lower-risk business model associated with retail banking is more attractive, we also feel mortgage and SME lending is positive for society. By combining lower-cost mortgages with prudent lending practices, it is helping provide access to affordable housing to the public, while SME lending remains a key driver of long-term economic growth.

 

Consequently, we favour names such as Nationwide Building Society, Lloyds Banking Group and RBS over the likes of Deutsche Bank, which we deem uninvestable.

 

ESG characteristics are also generally strong within the insurance sector and both AXA and Zurich are two of our strongest holdings on this basis, fully integrating ESG factors throughout their business practices such as underwriting as well as in their investment portfolios.

 

We believe integrating ESG in this way allows them to research, identify and price environmental and social risk factors; this makes them better placed to avoid these risks if needed, thereby becoming more stable and resilient entities and making them more attractive compared to peers.

 

Moving to the electricity sector, we focus on companies that major in renewable energy, and/or specialise in the transmission (National Grid) or distribution of energy (Western Power Networks) as we believe these segments of the electricity sector immunise our portfolios from energy transition risk.

 

Orsted is a particularly good example of the type of company in which we look to invest, with the management delivering on their aim to transition from fossil fuels to green energy. While the business model, until recently, was focused on coal-fired power generation and oil exploration and development, it now generates its power from wind farms, solar and biomass-fired stations.

 

In addition to this shift to renewables, management have also demonstrated an impressive safety record and a robust commitment to social factors through a range of employee wellbeing policies.

 

Elsewhere, the telecommunications sector contributes towards raising standards in health, education, employment and empowerment of local communities, providing the infrastructure of the knowledge economy, dematerialisation and enabling other sectors of the economy to move towards sustainability.

 

Major telecommunications with wireless networks can make a significant contribution in developing countries where mobile networks ‘leapfrog’ fixed networks. Mobile networks will be increasingly required with the rise of Internet of things/connected devices and helping facilitate the move to a lower carbon economy: driverless electric cars will need to be powered by 5G networks for example.

 

Having access to shelter is one of the most basic human needs alongside food and clothing and companies that provide high-quality affordable housing are another vital part of a sustainable society. This covers companies involved in the construction, development, ownership and letting, management and maintenance of housing.

 

We believe social housing provides several key social benefits within the UK. In the main, social housing providers have operations that fall into two segments, homes available for social letting at sub-market rent and a housing development portfolio, and we view both aspects as positive.

 

In summary, the SF Corporate Bond Fund has been able to deliver market-leading returns while exposing clients to lower levels of volatility than its index. We have achieved this by investing in companies and bonds that are of benefit to the broader society and environment while avoiding those that are not – and would therefore continue to challenge those ingrained views that sustainable bond funds will inherently lack investment opportunities.

 

Discrete years' performance* (%), to previous quarter-end:

 

Dec-19

Sep-18

Sep-17

Sep-16

Sep-15

Liontrust Sustainable Future
Corporate Bond 2 Inc

11.8

-3.6

7.2

10.5

0.5

iBoxx Sterling Corporate
All Maturities Index

11.0

-2.2

5.0

11.8

0.6

IA Sterling Corporate Bond sector

9.5

-2.2

5.1

9.1

-0.3

Quartile

1

4

1

1

1

 

* Source: Financial Express, as at 31.12.19, primary share class, total return, net of fees and interest reinvested.

 

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well-regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, January 30, 2020, 9:24 AM