Head of Portfolio Management Paul Warner, alongside Analyst Sarah Warner, provide insight into their ‘green’ investing process and their outlook for the sector.
How do you deal with different shades of ethical investing, and indeed, the interpretation of green being somewhat subjective?
Sarah Warner: Our green offering is divided into two mandates, Ethical and Socially Responsible. For both we maintain clear policies of what our investment criteria is. In the Ethical models we follow negative screening criteria which prevents us from investing in funds that are exposed to areas such as weapons, tobacco and animal testing. In the SRI models we are restricted to investing in funds that have a positive impact on society or the environment, so simply having a decent ESG score is not enough to warrant inclusion in either set of models.
Paul Warner: It is subjective and we do have to be pragmatic. The ‘boom’ in ESG investing has clouded the issue somewhat with many companies jumping on the band wagon, especially the passives. Many organisations are using external ESG metric providers, however the problem is that many look at ESG as simply a risk reduction exercise, rather than which companies are doing things positively. The metrics are also tweaked, so for example one of the biggest ESG data providers says: “For some companies, a portion of its risk may be considered unmanageable. For example, an oil company is not able to fully eliminate all its risks related to carbon emissions so that is factored out of the calculation”. We analyse a fund’s holdings and take a view its acceptability.
Are the portfolios you construct driven by asset allocation or fund selection?
PW: That’s the top down, bottom up question. We aim to outperform our benchmarks, both our internal ones and the IA managed sectors we compete against. We are therefore aware of these in our asset allocation but we also have views on markets and will make shorter term tactical changes. We then look at the funds available in our universe to see which ones best fit the purpose for both our long term strategy and our shorter term tactics.
How many funds would you typically hold within a ‘green’ portfolio?
SW: In the Ethical models we normally have around eight holdings and in the SRI models, up to twelve. We are more constrained on the Ethical models by the limited number of available funds that have definitive negative screening.
PW: Interestingly, when I did my exams, many moons ago, the optimal number of holdings on the risk/reward curve was eight. And that was direct equities. So with the added diversification that funds give us, these numbers are quite optimal.
Paul, are there any managers with whom you have consistently invested with during your 20 year association with ‘green’ investing?
PW: I’ve been investing in this space since 1994. Back then we had just 30 funds from which to choose. When we started the SRI models in 2009 our universe had grown to just shy of 100. Now we have over 240. In some of our models we still hold the BMO Responsible UK Income fund managed by Catherine Stanley. This was previously F&C Stewardship Income and before that Friends Provident. I can certainly remember back to Ted Scott and Hilary Aldridge who managed the fund, and that was in the last century!
The MitonOptimal fund rating system examines consistency of returns over a 5 year period. With so many new funds coming to market, how do you factor this in?
PW: The ratings were first created in the early 90s as a means to measure consistency of performance over different cycles. This helped to cut out the noise from the latest ‘sales’ story, and with so many new funds being launched in the 1980s and 1990s, there were a lot of good stories around!
SW: The ratings system does include funds with sub 5 year track records and shows us what their rating (with a 5yr track record) would potentially be. We can be flexible and if a fund manager with a good rating moves to set up a new fund, we will take this into consideration. However we would need to have a very good reason to select a fund without a full rating.
With value strategies showing signs of life, how has the more growth orientated ESG / SRI universe performed in recent weeks?
PW: We recently prepared a presentation in which there was a three month graph showing our Ethical and SRI UK holdings up to the end of October. All our funds had outperformed the FTSE All Share over that period. This partly reflects the fact that our funds tend to be invested a bit further down the capitalisation scale however this is more pertinent to our relative performance than value vs growth debate.
What is your outlook for the sector, and how will this play out through your portfolios?
SW: Given the crises affecting our world, such as the impact of urbanisation, resource scarcity and climate change and their increasing coverage in the media, the sector will be expanding at a significant speed. Investments that offer solutions to these crises (that are not going away) are essential and demand will increase. However within this we need to be cautious of ‘green washing’ and funds adopting ESG as a sales tactic. That’s why we undertake due diligence on our funds, looking at their underlying holdings alongside their sustainable investment criteria, and have regular dialogue with the fund managers.