Ethical portfolio: hope for a UN climate change summit boost

Six months after inception, we share an update on how our fund-based portfolio is performing and consider the upcoming COP26 summit in Glasgow.

Welcome to our first update of 2020 for the Money Observer ethical portfolio. A great deal has changed since our last piece – not only does Prime Minister Boris Johnson now command a substantial parliamentary majority, but the UK has also now left the European Union. How has this impacted our investment selections over the past three months?

The backdrop has been more positive in the intervening period and the total return for our selections since our last update came to 2.9%, a gain in value of £2,916. This means that since inception, the ethical portfolio has gained £1,971 or 2.0%.

At inception the portfolio had a mix of 75% equities and 25% bonds, so one way to benchmark performance is to look at the Investment Association’s (IA) mixed investments 40-85% equities sector.

Since we began this portfolio, the IA sector has returned 1.1% – so all told, an encouraging first six months for our ethical approach. Global equity markets performed well into the end of the year, capping off an exceptional year. It’s worth remembering that markets entered 2019 with an expectation of three interest rate hikes from the US Federal Reserve, but got three interest rate cuts instead.

That about-turn from the US Federal Reserve undoubtedly changed the mood music, from concern over deteriorating global economic data and the ripple effects from trade wars, into a much more optimistic outlook. It’s unlikely that 2020 will see the same again by way of scale of monetary stimulus, but it helps explain the outcome for 2019.

Meanwhile, here in the UK we saw a meaningful bounce after the general election result. That seemed less a view on it guaranteeing our departure from the EU and more a sense of relief that it provided certainty: markets generally like black or white rather than grey.

In particular, UK-listed companies more exposed to the domestic economy typically posted the strongest gains. You can see this clearly in the performance of one of our selections, our very own Castlefield B.E.S.T Sustainable UK Smaller Companies fund, which posted a total return of 12.5% since our last update. It is currently comfortably the leading performer among our selections since inception, with a total return of 12.3%.

As a reminder, we included this fund in the ethical portfolio as we believe it to be unique in offering both UK small-cap exposure and an explicit sustainability mandate. Performance was boosted not just by the more favourable sentiment to domestic names, but also by its position in Consort Medical, which received a takeover bid from Swedish-listed Recipharm AB.

Structural trends

Elsewhere, the Liontrust Sustainable Future Global Growth and Liontrust Sustainable Future UK Growth funds both produced strong gains since our last report, with total returns of 8.9% and 8.4% respectively. While the tailwinds from supportive markets help,  the Liontrust team’s strategy is focused on structural trends and stock selection, meaning short-term cyclical effects have a less important role to play in driving returns. The solid start the pair have made in part reflects positive contributions from a number of different assets, from US industrial software providers through to Scandinavian banks and UK healthcare innovators.

Against those gains, two of our equity picks have given up some ground since our last update – Greencoat UK Wind investment trust and the Sarasin Food & Agriculture Opportunities fund. We highlighted Greencoat last time as the top performer over the initial three-month period, as well as noting its punchy premium to net asset value (NAV). A period of short-term softness in such circumstances isn’t too surprising really, while late in January the renewable energy infrastructure sector was knocked by a bearish analyst report. Part of the report related to lower power prices feeding into the NAV calculations of companies such as Greencoat – fair enough in the short term, but prices can and do move both ways.

We tend to look beyond temporary factors, so it’s the long-term assumptions that concern us. Still, the bearish report also questioned whether new  projects in the renewable energy sector may cannibalise returns for the sector, something which would indeed have wider implications. We’ve been happy with the approach to an evolving energy market that the Greencoat team has outlined to us, but will be questioning them again when we meet with the company for a regular update in the coming months.

US farming drag

As for the Sarasin fund, it’s the case that some of its best-performing stocks from the first half of the year – before we launched this ethical portfolio – went through a more fallow period later on. The team has highlighted tough conditions for US farmers, which held back that part of the fund from participating in the rally seen in the final quarter of 2019.

In addition, the chief executive of one of the fund’s largest positions is to stepdown, an announcement that saw the stock switch from being the best contributor to the weakest performer in  successive quarters. As with Greencoat, this seems symptomatic of a short-term reaction, whereas we like the fund for its exposure to the structural changes in the global food economy.

What of our bond funds? Both the Rathbone Ethical Bond Fund and Royal London Ethical Bond Fund nudged ahead in performance terms, with total returns since the previous update of 2.8% each – closely matched, as we’ve come to expect from this couple of leading funds over the several years that we’ve been tracking them. So far, they are doing just the job we would expect them to do, with less stellar returns than the leading equity funds but holding their own and performing better than those funds whose nearer-term returns have been more muted.

Having primarily focused on the equity strategies to date – which after all represent the majority of our portfolio – we plan to discuss their ethical credentials in greater detail later this year. All told, over the first six months of the portfolio six holdings have performed better than the IA sector average benchmark, with three falling behind. That’s a proportion that seems fairly typical, particularly over such a short period when the underlying managers are all long-term in their approaches. The type of themes that these strategies are looking to invest in and benefit from are all expected to play out over several years, evolving along the way and seeing new themes develop.

COP26 opportunity

More broadly, it’s a hugely important year in the UK, with Glasgow hosting the 26th United Nations Climate Change Conference, known as COP26. Holding the presidency gives the UK the perfect chance to shape proceedings and to seek game-changing outcomes of the kind achieved by the French stewardship of COP21 in Paris in 2015. That conference saw the introduction of the ambition to limit global warming to 1.5°C and was seen as a resounding success in its statement of intent. If the UK can achieve something similar, it will have ramifications for investment markets and perhaps an acceleration of trends that have become more evident in recent years.

Energy efficiency and renewable power generation are only going to grow in importance, while fears over the risk of ‘stranded assets’ – investments whose capital value might become impaired due to their incompatibility with a decarbonising world – will continue to linger over the sectors and businesses tied closely to fossil fuel extraction.

This ethical portfolio is focused on the future and on avoiding such stranded asset risks, a trend that will become more and more prevalent. We’ll touch on these themes and the build-up to COP26 in future columns.

Funds with long-term themes show their mettle over a short timeframe

  SEDOL Investment at launch (£) Current value (£) Total return since last update (£) Total return since last update (%) Total return since inception (£) Total return since inception (%) Historical yield (%)
EQUITY   75,000 75,800          
Stewart Investors Worldwide Sustainability B8319S6 20,000 19,820 254 1.29 -180 -0.90 0.63
WHEB Sustainability B8HPRW4 15,000 14,790 659 4.66 -210 -1.40 0.00
Sarasin Food & Agriculture Opportunities B8GJCL1 10,000 9,159 -371 -3.90 -841 -8.41 1.09
Liontrust Sustainable Future Global Growth 3003006 7,500 7,862 645 8.93 362 4.82 0.28
Liontrust Sustainable Future UK Growth 3002876 7,500 7,996 620 8.40 496 6.61 1.62
Castlefield B.E.S.T Sustainable UK Smaller Companies B1XQNH9 5,000 5,616 623 12.47 616 12.31 0.56
Greencoat UK Wind IT B8SC6K5 10,000 10,558 -229 -2.12 558 5.58 4.88
FIXED INCOME   25,000 26,171          
Rathbone Ethical Bond B7FQJT3 12,500 13,129 356 2.79 629 5.03 3.95
Royal London Ethical Bond BJ4KSY8 12,500 13,043 360 2.83 543 4.34 3.29
Total   100,000 101,971 2,916 2.94 1,971 1.97 1.80
Benchmark: IA mixed investment 40-85% shares   100,000 101,310 1,328 3.11 1,310 1.31 N/A

Note: Inception of the portfolio is 1 August 2019. Source: Castlefield, as at 1 February 2020

Simon Holman is a partner at Castlefield Investment Partners.

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