Will McIntosh-Whyte, manager of Rathbones’ range of four risk-rated sustainable multi-asset funds, answers questions about why sustainable investing makes sense, what he hopes to achieve with this range and what some of the challenges and opportunities are in managing sustainable multi-asset portfolios.
1. Why is sustainable investing gaining traction?
There’s no denying that demand for sustainable investing has risen sharply. This has been driven in large part by people wanting to not only reflect their values in their investments, but also make a positive impact with them. The trend has been given extra impetus from regulatory changes requiring advisers and investment managers to add environmental, social and governance (ESG) considerations to their suitability checks. So yes, sustainable investing is on the rise, but how you go about it is crucial – how do you know if your approach is truly sustainable, for the planet and for investment returns?
2. How can you cut through the noise and green-signalling to identify what is truly sustainable?
Though it’s rarely acknowledged, there is lot of grey area, nuance and subjectivity involved in analysing companies for their sustainability credentials. It requires an active, common-sense approach by those who have experience and expertise in the area. For this reason, our day-to-day management of the Rathbone Greenbank Multi-Asset Portfolios (RGMAPs) is supported by Rathbone Greenbank Investments (Greenbank), who have been pioneers in the development of sustainable investing since 1997. Their ethical, sustainable and impact (ESI) research team use their proprietary database of profiles on companies, governments, and other entities to independently scrutinise every asset in our funds against our pre-determined and clear sustainability criteria. The Greenbank team analyses the specific merits of each entity’s activities in detail and how it addresses sustainability and responsible business issues, as well as the quality of its response. This ensures our funds only invest in ways that are truly aligned with the UN’s Sustainable Development Goals (SDGs), an agenda for global sustainable development adopted in 2015 by all UN member states.
Just to give one example of the complexities involved, take the full lifecycle of an electric vehicle. When you delve into it, you start to uncover some difficulties from a sustainability perspective, such as the cobalt mining that is necessary for making the batteries. Often, only relying on third-party ESG ratings and not doing your own in-depth analysis, can mean missing some of these crucial sustainability issues. This is one of several challenges that our stewardship team have been exploring in a series of articles for our quarterly InvestmentInsights publication.
3. What are the benefits & drawbacks of using third-party ESG data?
While we do use ESG data from external providers as part of our analysis, we do not rely on that alone. We find these external sources a useful starting point for our own research as it can be a quick way to identify red flags that would rule something out or highlight areas of operational strength or weakness to investigate further. We’re also able to take some of the raw data points such as health and safety stats, emissions, etc. and feed them into our own database. As with any external information source, it’s important to understand the methodology used in order to know what the data is and – more importantly – isn’t telling you. For example, some ESG ratings are relative to individual sectors and are highly dependent on what issues (e.g. data security, climate change, employee relations) that the data provider has determined to be most important for that sector. In some cases we find quite a good alignment between their views and ours, but often we’ll have quite a different view. There can also be a bias in external ratings towards companies that report more information. A company might get a poor score not because it’s worse than its peers, but because it just isn’t putting as much information into the public domain. So it’s important to do further digging.
Our in-house research into organisations draws on company reports, monitoring of news flow, company meetings, NGO reports and other third-party sources. These include specific benchmarks and data sources such as environmental impact tracker CDP’s scoring, Workforce Disclosure Initiative and Access to Medicine Index. Researching a company’s sustainability credentials involves a great deal of data analysis as well as qualitative research. We of course have an objective framework for rating companies from a sustainability point of view, but we think it’s crucial to always have a human sense check at the end.
4. Can you tell us more about your criteria, and how you define ‘sustainable’?
For us, sustainable means investing in companies and entities which are benefiting people and planet by working in ways or providing goods and services that support sustainable development. To do this in practice, all equities and corporate bonds within our portfolios must align to one of Greenbank’s eight sustainable development categories which map to the UN SDGs. These eight categories focus on crucial areas of sustainability such as energy and climate, health and wellbeing and resource efficiency. We also believe that some areas are simply inconsistent with sustainable development, which is why we screen them out of our portfolios. For us, oil and gas companies and miners don’t belong in sustainable funds.
We believe it is important to apply sustainability criteria to all asset classes. We use a customised criteria for more complex asset classes, for example government bonds and commodities, rather than simply excluding them fully or alternatively compromising on sustainable values.
Importantly, Greenbank can veto investments which do not meet our funds’ responsible investment policy, ensuring it’s applied without bias or influence from us, the fund managers. Equally the team, supported by Rathbones’ wider stewardship resource, continues to actively undertake stewardship activities such as voting, engagement and monitoring on behalf of our investors.
5. Can you achieve true diversity in a sustainable portfolio? Doesn’t the sustainability criteria limit your choices?
We believe it is not only possible, but necessary to create sustainable portfolios that are genuinely diversified. It’s simply not enough to just be ‘sustainable’. Everything in the portfolio has to either generate a return or hedge a risk, and you need to have the right balance of both. What we don’t want to be is just another questionably diversified ‘60-40’ fund with a sustainable badge thrown on it.
Given that all investments must support sustainable development, providing diversification while keeping true to your sustainability principles can be done, it just takes a little more work. For instance, government bonds are an important tool for multi-asset portfolios, and we believe they have a place within sustainable portfolios too given the significant positive impacts governments can have on the environment and society. But, for their bonds to be eligible for inclusion in our funds, countries must pass three out of four of our sustainable qualifying criteria related to military spending, corruption, civil liberties and climate change action. While bonds are available to help diversify our portfolios, the universe is reduced – for example, US Treasuries are currently ineligible for inclusion because of the American government’s inaction on climate change and heightened defence spending. But Japanese and UK government bonds have passed our criteria and are held right now. However, there are supranational bonds in many countries and currencies that can offer similar exposure to sovereigns, but in a more sustainable way. Another asset class with current limitations is commodities. They can be particularly valuable as a hedge against inflation. However, it is difficult to ensure they align to sustainable development due to their mining processes. So, to diversify and hedge risks that commodities and similar assets would provide, we can use other tools, such as foreign currencies and structured products, that balance our risks without compromising our values.
In order for our funds to be able to invest in commodities (apart from fossil fuels, which are excluded due to their damaging impact on the climate) we have created a set of sustainability criteria which they must meet. These include providing supply-chain transparency, with independent verification that there are no significant issues regarding labour rights, human rights or environmental degradation across the supply chain. Due to our strict criteria, commodity investments are excluded from our portfolios for now. However, we believe as we continue to transition to a more sustainable world over time there may be some commodities which meet the criteria, so we’re not ruling them out for future consideration.
6. How does risk management for sustainable multi-asset portfolios compare with managing risk for a traditional multi-asset portfolio?
In order to construct portfolios effectively and manage risk, we use our forward-looking Liquidity, Equity-type risk and Diversifiers (LED) framework, which is the same one we’ve been using for years in our other multi-asset portfolios. Because fixed income, equities and alternative investments can behave in different ways, even compared with similarly labelled investments, we want to make sure that assets are categorised by their liquidity and correlation to equities, particularly during periods of market stress. This helps protect our portfolios adequately and limit drawdowns.
For example, within the Equity-type risk bucket we include investment grade corporate bonds and high yield bonds, alongside equities. We do this because during a market downturn these bonds tend to correlate highly to equities and therefore are unlikely to provide much protection when you need it most. This must be considered carefully when constructing a portfolio.
We use several other tools to manage risk. These include assets within our Diversifiers bucket that can provide returns that are uncorrelated to equities, for example put options and structured products linked to interest-rate volatility or currency momentum. These assets aren’t considered Liquidity assets because they don’t have the same ease of buying and selling quickly in stressed markets compared with, say, developed market government bonds. We also have the ability to hedge our currency exposure, enabling us to choose the best companies globally and only take the currency exposures we want. For example, we can retain exposure to the yen, which tends to act as a safe haven during difficult markets, as a risk-management tool.
This is a financial promotion relating to a particular fund range. Any views and opinions are those of the investment managers, and coverage of any assets held must be taken in context of the constitution of the fund and in no way reflect an investment recommendation. Past performance should not be seen as an indication of future performance. The value of investments may go down as well as up and you may not get back your original investment.