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Q: What are the differences between sustainable equity and credit investing?

A: One of the major differences between sustainable equity and credit investing is that within credit we can access sectors that are out of reach to equity investors. This may be because they have no public listing, or they are sectors which offer the least value to equity investors but can be attractive to bond investors. One example of a sector which is very important in the sustainable credit space is utilities, especially renewable energy companies. While this sector offers very little growth, it is at the same time very stable, which makes it attractive from a credit perspective.

I believe a big advantage of RLAM’s proprietary ESG research is that it helps uncover opportunities in those credit areas not covered by third-party equity-oriented ESG ratings. One sector we like in particular is social housing, where there is no publicly listed equity and therefore little third-party coverage. Social housing, which provides affordable decent housing for the wider population that cannot afford to buy a property, also demonstrates how a company’s sustainable and credit characteristics can interact.

The other difference between credit and equity sustainable investing comes down to risk and returns. Unlike equities, the risk and returns for fixed income investors is very asymmetric. Our sustainable credit portfolios are highly diversified in order to reduce what we call ‘idiosyncratic risks’. So, whereas in the equity space portfolios tend to be more concentrated, typically holding less than 100 holdings, we run highly diversified portfolios of more than 200 holdings to reduce the risks of defaults hurting fund performance.

A: While we think sustainable credit is still behind sustainable equity, it is catching up fast. At the same time that we have seen more and more corporates starting to issue green bonds and sustainability-linked bonds, there is now also the trend of governments starting to issue green government bonds because of the strong demand for that green label. If we begin to see all sovereign states start to issue green bonds, then in my view sustainable credit could become larger than sustainable equity investing.

Q: What motivated RLAM to launch the Royal London Global Sustainable Credit Fund in February this year?

A: We have seen growing investor demand for strategies that integrate ESG factors into the investment decisions and sustainable credit strategies have witnessed strong inflows. We are also seeing that societal and environmental changes – some related to the Covid pandemic and others to global warming – are driving the growth in sustainable strategies. With the rise of concerns surrounding climate change, we have seen more demand for green bonds given they don’t have a high carbon impact. However, while we want to encourage companies to develop green projects, our portfolio has little exposure to ‘green’ bonds and ‘sustainability-linked’ bonds. Instead, we believe we can find issuers with better ESG characteristics by carrying out our own sustainable analysis rather than fully relying on the green label.

A: We already have a sterling sustainable credit proposition which has been very successful, but clients were also interested in a global version. The advantage of being global is the size of the investment universe, which is bigger than the sterling universe. This allows the fund to be truly diversified by sectors and issuers, and invest in some sectors that are better represented in specific geographies.

A good example is the healthcare sector, which is a very important sustainable sector for us. It is an area of the market dominated by the US pharmaceutical companies. While in the sterling universe we only have three issuers, namely AstraZeneca, GlaxoSmithKline and Pfizer, in a global universe the number of issuers within the healthcare sector increases to more than 80, allowing us true diversification.

If you look at the environmental side, some geographies are ahead in the transition to green energy compared with others. For example, Europe is well ahead in decarbonising its economies compared with the US or Canada. So, while it can be a challenge to find some renewable energy players in North America, the opportunities in Europe are numerous. In Norway, some 98% of the electricity generated comes from renewable sources, which is something the portfolio can take advantage of by being globally invested.

Q: The global credit universe is huge, so how do you define the fund’s investable universe?

A: If we look at the global investment-grade universe, there are some 2,300 issuers and over 14,000 holdings to invest in, so it is a very, very large universe. We begin breaking this down by using RLAM’s definition of sustainability, so all of our sustainable funds only invest in companies that aim to positively benefit society.

We then screen out issuers from sectors that have negative environmental and social impact, such as fossil fuel extraction, mining companies, tobacco companies, beverages companies that promote irresponsible drinking, and gambling companies. This means the fund does not invest in companies that do significant harm to society and the environment.

Once we’ve narrowed the universe to that point, we apply our proprietary sustainable process. This process consists of a stock-by-stock, issuer-by-issuer analysis, looking at the ESG factors and screening for the companies that have the best ESG factors. We also use currency filters, with the fund’s primary focus being on the dollar, euro, sterling and some Nordic currencies.

Finally, we look for issuers that best fit within our current 10 sustainable themes, such as essential infrastructure, decarbonisation, health, the circular economy and community funding. Once we have applied all the filters, we are able to reduce our investable universe down to about 600 issuers, which is much more manageable.

Q: After establishing the universe, how do you go about selecting credit names for the portfolio?

A: First, it’s a combination of top-down sector analysis and bottom-up stock selection. Fund performance will always be generated by stock selection and sector allocation, so the first thing we do is look at those sectors which best fit within our 10 themes and identify those geographies which are best represented. The second stage for stock selection is to look for the leading companies within each of the sectors and then go about doing our full sustainable and credit analysis.

We have a team of 15 credit analysts that cover sterling and global credit, and nine responsible investment analysts that conduct all the ESG analysis. So not only will the size of the position we take reflect the credit rating, valuation and financial strength, but also the company’s ESG credentials.

Q: Where is the fund currently finding the best investment opportunities and what are the key risks investors need to consider?

A: Starting with the risks, the key one we consider is greenwashing. This is where a company gives a false impression about how their product or services are more environmentally sound than they really are. The good thing about the way we manage money for both our sustainable equity and sustainable credit funds is that our investment process does not rely on green labels. We have a bespoke process where we really try to separate the companies which are genuinely sustainable from those that are only good at advertising their ESG credentials.

In terms of investment opportunities, some of the best at the moment are in those sectors that are dealing with the urgent problems of climate change and global warming. So, any companies involved in green energy, such as those lending to wind and solar farms.

Another sector which is very important is related to recycling waste and the circular economy theme. For example, those companies using high levels of recycled materials in the manufacturing process of their products. These types of companies – such as packaging companies that use 100% of recycled aluminium to make cans for beverage companies – are growing and will continue to do so.

A: The first thing to note is we have an 18-year track record in sustainable investing at RLAM. This is not something we have just started to do when it became on-trend and fashionable. Second, we have an in-house sustainable process that is bespoke to us and does not rely on ESG data providers and labelled bonds. The fund also benefits from the expertise of pulling together the ideas from multiple teams at RLAM, from our global credit team to our equity and responsible investment desks. We are really pulling together the best teams to work on this fund.

The fund also benefits from the expertise of an external advisory committee, which is made up of four independent industry experts. Our advisory committee has been in place since we started managing sustainable funds 18 years ago. ■

The value of investments and the income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. For Professional Clients only, not suitable for Retail Clients. This is a financial promotion and is not investment advice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.

The Royal London Global 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.

Issued in October 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.