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Our views 16 August 2021

JP’s Journal: A tale of two halves

5 min read

With the recent launch of RLAM’s European Sustainable Credit Fund we now have a range of strategies offering exposure to sustainable credit bonds, including our multi asset funds.

I am frequently asked how credit investing for multi asset funds differs from the approach to running single asset strategies – so I thought I would set out a simple 10-point guide to how we do sustainable credit.

  1. RLAM’s Sustainable approach is based upon positive investing (ESG leaders or a net benefit to society) and is supplemented by ethical exclusions (negative screening). Our ethical strategies are not part of the sustainable range because they have only negative screens. 
  2. RLAM have a vigorous internal screening process, supported by our Responsible Investment team, to highlight bonds that fail our ESG leadership and net benefit criteria, with further oversight from an External Advisory Committee. This approach allows us to focus on true sustainability rather than a box ticking approach. 
  3. Credit markets are not simple replications of equity markets. There is a much larger choice of debt instruments and credit index composition is different from equity weightings.
  4. Sterling sustainable credit has a smaller universe than unconstrained approaches. We estimate a reduction of approximately 30-40%. Our approach is to invest in non-sterling credit (hedged back to sterling) where there are opportunities to add value.
  5. Credit has different characteristics to equity; this merits a different approach. Credit risk is asymmetric with capped upside but with the potential to lose all value. This means that credit portfolios will have many more holdings than equity strategies and that issuer diversification is important.
  6. We apply our credit investment philosophy to all RLAM sterling credit strategies; for sustainable funds this means the application of our investment criteria to our core investment approach. As a result, our sustainable funds have a bias towards secured debt.
  7. Sector variations are apparent between unconstrained and sustainable sterling portfolio: sustainable strategies have higher weightings in social housing, infrastructure, community finance and health with lower exposures to industrial and consumer goods companies.
  8. Our sustainable approach takes a holistic approach to net benefit, and is not simply defined by environmental impact, and as such also focuses on other beneficial areas like infrastructure. This approach also allows us to avoid the pitfall of just picking sectors that score well on Scope 1 and Scope 2 carbon emissions, resulting in over concentration in financial sectors.
  9. Dedicated sustainable credit funds are different to the credit components of multi asset strategies. This reflects the diversification achieved through the equity component in multi asset strategies. The screening process, however, remains the same. What that means is that we hold more concentrated positions in those strategies with higher equity weightings.  
  10. Within our multi asset credit segments we complement our equity positions. This means being aware of total company exposure and having heightened focus on areas not available to equity holders – such as social housing.

Cash and rates

The main focus last week was on US data. After a series of upside surprises, July was broadly as expected with CPI staying at 5.4% while core CPI fell from 4.5% to 4.3%. There was quite a mixed pattern of price increases, with continued evidence of some re-opening effects but the supply-shortage linked effects, specifically autos-related, showing some signs of calming down. Food and energy price inflation were relatively strong on the month, but prices were flat or rose only slightly in categories like apparel and household furnishings. We think we have seen the peak in headline inflation but business surveys continue to suggest some pipeline inflationary pressures.

UK GDP came in as expected; consumer spending was a bit stronger while fixed investment and net exports were weaker. Overall, the bounce in the economy during Q2 marks a strong recovery from the Q1 lockdowns and moves the UK economy a step closer to post-pandemic normalisation. However, Q3 is likely to be slower than the prior quarter, given so much of the reopening happened in Q2 and uncertainty around how the economy will react as the furlough scheme is unwound.

Cash markets were unchanged and there was little movement in the pound. 10-year yields in the UK stayed around 0.6%, while there was a small rise in US rates to 1.3%. Break even inflation nudged marginally higher in the US but was unchanged in the UK. There was little change in Euro rates.

Credit

The summer lull was more apparent in Europe than the US where new issuance continued. In the UK there was little of note with credit spreads near the lows of the year. At the short end of the market spreads are pretty thin but we have been able to position our strategies with extra yield, relative to benchmarks, through higher weightings in asset backed bonds.  

In high yield, spreads stabilised after a few weeks of widening. Events in China have pushed index yields higher and there are pockets of value emerging here.

 

Past performance is not a reliable indicator of future results. 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. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.

The Royal London European Sustainable Credit Fund is a sub-fund of Royal London Asset Management Bond Funds plc, an open-ended investment company with variable capital (ICVC), with segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. It is a recognised scheme under section 264 of the Financial Services and Markets Act 2000. The Investment Manager is Royal London Asset Management Limited. For more information on the trust or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk. Most of the protections provided by the UK regulatory system, and the compensation under the Financial Services Compensation Scheme, will not be available.