Comparing Ethical and Sustainable credit at RLAM


Jonathan Platt

7 December 2018

Ethical and Sustainable bond funds can sometimes seem like different labels for the same thing. We view these differently – we use the same underlying investment philosophy, but while there are some similarities between our Ethical and Sustainable bond funds, there are also some obvious differences. 
RLAM believes that environmental, social and governance (ESG) issues are vital in all credit research. As such, we combine rigorous financial analysis with assessments of how ESG factors could influence the risk profile of the issuers. We have to judge whether the overall risk profile, based on financial and ESG factors, is appropriately reflected in the valuation of bond. We combine this analysis with a number of other features, in particular, a bias towards secured debt or bonds with strong covenant protections and an emphasis on portfolio diversification. Overall, our approach allows us, as active managers, to take advantage of credit market inefficiencies arising from over reliance on credit ratings and benchmark composition.
The RL Sustainable Managed Income trust, managed by Richard Nelson, uses the above approach and applies further criteria, to give preference to issuers where the provision of debt financing will support the move toward a more sustainable society. This can be through supporting entities with socially and environmentally useful products and services, or those with strong ESG management. To this end we include four themes which we believe will be a net benefit for society:
Community: covering education, health and social care
Housing: with a focus on social and affordable housing
Utilities & Environment
Infrastructure
These themes focus on those areas where we believe there is a clear benefit to society and also a clear long-term investment case. This means that portfolios will look for opportunities in a wide range of areas such as social & affordable housing, hospitals, transport, roads, schools & universities, water infrastructure, electricity distribution and telecommunication. We aim to have at least half of the relevant fund’s bond holding in securities linked to one of these themes, subject to sufficient portfolio diversification being achieved.
Our approach means that Sustainable Managed Income will invest in bonds based upon both our credit research and ESG analysis. We believe that this offers our clients a clear investment process, with a majority of credit bond exposure reflecting our four investment themes or entities which lead their industries in ESG management. This allows RLAM to combine our long-held investment philosophy with a rigorous emphasis on sustainability. Although the primary element of our approach is based on positive selection, the fund applies an absolute prohibition on investing in any company with certain features e.g. manufacturing tobacco based products, armament production or product testing on animals other than for human health. There is also a prohibition on debt issued by entities with unacceptable corporate governance structures. The result of this process, in our opinion, is a corporate bond fund with a lower environmental impact and a more positive social impact than recognised indices, benchmarks and peer groups.
The Sustainable Managed Income has recently moved from the IA Unclassified sector to the IA Corporate Bond sector; this reflects the composition of the fund and will give investors the opportunity to make meaningful comparisons with other sterling corporate bond funds.
The RL Ethical Bond fund employs the same underlying investment philosophy and, similar to Sustainable Managed Income, has an outright prohibition on holding debt issued by certain entities. However, there are some key differences. First, the Ethical Bond fund does not employ a sustainable thematic policy. Second, the fund is not in the IA Corporate Bond sector, but the IA Strategic Bond sector, reflecting the exposure to unrated and sub-investment grade bonds being above 20%. Third, the Ethical Bond fund is considerably larger, with a more diversified portfolio.
The Ethical Bond fund is managed by Eric Holt, one of the most experienced and highly performing credit bond managers in the UK. Eric, who also manages RL Sterling Extra Yield Bond fund, has managed the Ethical Bond fund for over ten years and has achieved impressive outperformance of the fund’s benchmarks. The use of unrated and off-benchmark bonds is a key feature of the portfolio and differentiates the fund from its peer group. By following a less constrained and more ethically orientated investment policy, Eric has built a robust portfolio comprising bonds often overlooked by investors. 
At RLAM we believe both Sustainable Managed Income and Ethical Bond offer investors a clear investment choice relative to more benchmark orientated credit funds. Both follow the same underlying philosophy and are supported by RLAM credit research team. The Sustainable Managed Income employs sustainable criteria and adopts a thematic approach whilst Ethical Bond offers greater diversification and a less “credit rating” orientated portfolio.

Ethical and Sustainable bond funds can sometimes seem like different labels for the same thing. We view these differently – we use the same underlying investment philosophy, but while there are some similarities between our Ethical and Sustainable bond funds, there are also some obvious differences. 

RLAM believes that environmental, social and governance (ESG) issues are vital in all credit research. As such, we combine rigorous financial analysis with assessments of how ESG factors could influence the risk profile of the issuers. We have to judge whether the overall risk profile, based on financial and ESG factors, is appropriately reflected in the valuation of bond. We combine this analysis with a number of other features, in particular, a bias towards secured debt or bonds with strong covenant protections and an emphasis on portfolio diversification. Overall, our approach allows us, as active managers, to take advantage of credit market inefficiencies arising from over reliance on credit ratings and benchmark composition.

The RL Sustainable Managed Income trust, managed by Richard Nelson, uses the above approach and applies further criteria, to give preference to issuers where the provision of debt financing will support the move toward a more sustainable society. This can be through supporting entities with socially and environmentally useful products and services, or those with strong ESG management. To this end we include four themes which we believe will be a net benefit for society:

Community: covering education, health and social care

Housing: with a focus on social and affordable housing

Utilities & Environment

Infrastructure

These themes focus on those areas where we believe there is a clear benefit to society and also a clear long-term investment case. This means that portfolios will look for opportunities in a wide range of areas such as social & affordable housing, hospitals, transport, roads, schools & universities, water infrastructure, electricity distribution and telecommunication. We aim to have at least half of the relevant fund’s bond holding in securities linked to one of these themes, subject to sufficient portfolio diversification being achieved.

Our approach means that Sustainable Managed Income will invest in bonds based upon both our credit research and ESG analysis. We believe that this offers our clients a clear investment process, with a majority of credit bond exposure reflecting our four investment themes or entities which lead their industries in ESG management. This allows RLAM to combine our long-held investment philosophy with a rigorous emphasis on sustainability. Although the primary element of our approach is based on positive selection, the fund applies an absolute prohibition on investing in any company with certain features e.g. manufacturing tobacco based products, armament production or product testing on animals other than for human health. There is also a prohibition on debt issued by entities with unacceptable corporate governance structures. The result of this process, in our opinion, is a corporate bond fund with a lower environmental impact and a more positive social impact than recognised indices, benchmarks and peer groups.

The Sustainable Managed Income trust has recently moved from the IA Unclassified sector to the IA Corporate Bond sector; this reflects the composition of the fund and will give investors the opportunity to make meaningful comparisons with other sterling corporate bond funds.

The RL Ethical Bond fund employs the same underlying investment philosophy and, similar to Sustainable Managed Income, has an outright prohibition on holding debt issued by certain entities. However, there are some key differences. First, the Ethical Bond fund does not employ a sustainable thematic policy. Second, the fund is not in the IA Corporate Bond sector, but the IA Strategic Bond sector, reflecting the exposure to unrated and sub-investment grade bonds being above 20%. Third, the Ethical Bond fund is considerably larger, with a more diversified portfolio.

The Ethical Bond fund is managed by Eric Holt, one of the most experienced and highly performing credit bond managers in the UK. Eric, who also manages RL Sterling Extra Yield Bond fund, has managed the Ethical Bond fund for over ten years and has achieved impressive outperformance of the fund’s benchmarks. The use of unrated and off-benchmark bonds is a key feature of the portfolio and differentiates the fund from its peer group. By following a less constrained and more ethically orientated investment policy, Eric has built a robust portfolio comprising bonds often overlooked by investors. 

At RLAM we believe both Sustainable Managed Income and Ethical Bond offer investors a clear investment choice relative to more benchmark orientated credit funds. Both follow the same underlying philosophy and are supported by RLAM credit research team. The Sustainable Managed Income employs sustainable criteria and adopts a thematic approach whilst Ethical Bond offers greater diversification and a less “credit rating” orientated portfolio.

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.