Ethical investing – Thinking differently
15 November 2018
Rob Kingsbury spoke with Bryn Jones, manager of the Rathbone Ethical Bond Fund, about why he changed the ethical screening process and the way he balances achieving ongoing positive returns with the fund’s investment philosophy
When Bryn Jones, manager of the £1.23bn Rathbone Ethical Bond Fund took over the running of the fund in November 2004, he turned the ethical screening of the fund on its head. At that time the positive ethical screening took place at the beginning of the process. This, Jones felt, restricted the ability of the fund, so he moved that part of the process to the end.
“So philosophically we’re not picking something just because its green,” he says. “You can get blinkered by the question ‘Is it green?’ In behavioural finance terms, this is Anchoring on that fact. Ultimately, I felt that for the fund to outperform over the longer term, the focus should first be, ‘Is this a good investment?’ and then ‘Will it do what we want it to do for the fund?’
“The ethical screen then becomes a bonus. It’s a virtuous circle, in that a good investment return leads to a good social return and a good social return leads to a good investment return.”
The ethical screening of fixed income investments that could be included in the fund is carried out to a strict criteria by Rathbone Greenbank Investments. Jones says there are defined areas where the fund applies a negative screening (see Table 1). Equally, there are progressive or well-developed practices or policies which investment issuers need to have demonstrated in terms of positive impacts (See table 2).
“So we will find investments, corporate bonds, that we feel would be positive for the fund’s performance, excluding the areas we know cannot be invested in, and then it will go to Greenbank for scrutiny. Greenbank have an absolute veto. They could come back with an outright ‘No’, or they will see positives but want to monitor them, and sometimes we engage with the issuer, for example to ensure they have good social reporting where that may be lacking. Having Greenbank as an independent authority is good for the governance of the fund.
“In this way we are delivering good investment and ethical returns by keeping the different processes separate.”
By focussing on the investment process, Jones says, he and assistant fund manager Noelle Cazalis, are able to find and buy issuance from a range of companies. “We have a really interesting tail of smaller investments that we think will do very well for the fund,” he says. “These include things like renewable energy projects; wind turbines where the revenue generated is being pumped back into the local community; work with ex-offenders; canals and rivers charities and so on.”
When buying the bonds of smaller entities running these types of projects, Jones will often take a hands-on approach and go out into the field. “If a charity says the issue is secured against a number of properties, for example, it can be a good idea to go and look at those properties to see what they are and they are worth the value as a security. I also spend a lot of time doing due diligence so I can talk to investors meaningfully about where their money has been invested. I find it very interesting.”
While the fund is retail focussed, Jones says there are a number of institutional investors with money in it – fund of funds, large discretionary wealth investors, family office, pension funds and unions.
“It’s a form of social capitalism – we’re making money but at the same time we’re trying to make a better society. We’re a big fund, taking big money but we have the flexibility to be able to invest in smaller entities and to have an impact on local communities.”
There is a process the fund managers follow when researching an investment.
This starts with themes. The fund favours big themes, Jones explains. This could be regional or sector; social housing and insurance companies are two examples.
The fund managers then look at the credit side – using what they call the ‘4Cs plus’ model. The four Cs are:
1. Character of management – often assessed in face-to-face meetings
2. Capacity to pay – looking at balance sheet, income and cashflow, etc
3. Collateral – who has it and where is it held?
4. Covenants – the prospectus and protection for investors
The final C – the plus – is Conviction. “I’m not governed by a benchmark. If I don’t like something I won’t buy it,” says Jones.. “I drum that into my analysts, that if they lose conviction in an investment then we need to be looking closely at it. Equally, if there is some good news about and they really like something, then we should be looking at whether we buy more of it.
“If there is one key reason we have outperformed over the years it is because we don’t just follow the herd, we invest with conviction.”
The next stage of the process is to look at the valuation. “If we identify an investment sits within a good theme, it’s a good company, andit looks cheap, we’ll then run the ethical screen. If it gets through the screen then it goes in the portfolio universe. What we’re trying to do is buy high quality value – we’re primarily in the single A, BBB space – that is ethical.”
The fund is allowed to be up to 10% invested in non-rated companies (the latest fact sheet shows a distribution of 8.22% in non-rated investments). Jones sees this an area of opportunity for the fund. “There are usually some really good ideas, some very good companies and they are quite cheap. Benchmark funds won’t buy them as their risk teams tell them they can’t have them. Yet, when these companies get on the benchmark they can go up 8-10 points. Over the 14 years I’ve been running the fun, that has been a great way to add alpha.”
In terms of the targets of the fund, Jones says these are growing the assets, achieving and maintaining top quartile performance, as well as delivering ethical and social impact.
“People ask me why we invest in the smaller schemes, but if you can placing £100k-£200k into these local communities and making 5-6% return while they are getting a very good positive impact, it makes complete social-capitalism sense to me.”
After 10 good years of bond returns, Jones believes the next 2-3 years will be harder as interest rates rise and QE slows further. He is “wary” of the potential for a downturn in the next couple of years. As a result, balancing the need for yield (currently 4.3%) with protection within the portfolio is, he says, where he is focussed at the moment. “I think we will still generate positive returns but they are not going to be as exciting as they have been,” he concludes.
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