Sententia articles June 2020

In this issue

ESG during Covid-19 – a new era for the world and investing?

ESG (Environmental, Social, Governance) investing has been fighting for a long time to find its way in the world of financial management and investing. The approach has grown in popularity in the last couple of years due to not only a growing awareness of the term and education around what it means and how it can benefit both investors and the economy, but also due to companies innovating to create new products and services...

 

To switch or not to switch that is the question - thought-leadership piece from Adrian Boulding, Chief Innovation Officer of technology provider Spire Platform Solutions

Buy low - sell high is the objective of all speculators. But when it comes to pension plans, the buying takes place very gradually over a 40 year working life and the selling takes place almost equally slowly over a thirty year retirement...

 

ESG during Covid-19 – a new era for the world and investing?

ESG (Environmental, Social, Governance) investing has been fighting for a long time to find its way in the world of financial management and investing. The approach has grown in popularity in the last couple of years due to not only a growing awareness of the term and education around what it means and how it can benefit both investors and the economy, but also due to companies innovating to create new products and services...

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With ESG investing becoming more and more important, investors want to know that every part of their investment decision is delivering, and that includes their platform. With this in mind, we’ve now published our new ESG page. Over time we will also be adding videos and information about the ESG offerings from Fund Managers available through Novia. We are already highlighting those DFMs with ESG offerings on our DFM page and we hope that these lists will grow over time.

What has changed in society?

It might be somewhat early to see changes in all areas, or to confirm long term trends. However, as of the time of writing the lockdown has definitely brought about a shift in the way people are living their lives and moving within their communities. People have been inspired by the lower levels of pollution, less busy roads and sourcing their food from local independent farm shops rather than the supermarket.

Coronavirus has reminded everyone of the importance of respiratory health, with pollution being a major hastener of the death of millions around the world, ranking along with the likes of high blood pressure, diabetes and obesity. As reported by New Scientist, a recent study showed that the average person in Europe loses two years of life because of air pollution, and for a very significant number the years lost are considerably more. In fact, the most polluted cities have suffered more due to outbreaks of the new disease, according to a recent paper reported in an article in the Telegraph, providing evidence that ‘higher levels of some air pollutants correlates with increased Covid-19 mortality.’ It’s not hard to see why most people view climate change as at least as serious as coronavirus and want to see the world build back better.

How does this look in figures?

  • Figures from the online fitness store Wiggle showed bike sales in the UK increasing by 192% since the start of lockdown and Ebay’s figures showed new bike sales tripling in April, with sales of second-hand bikes up 23%
  • Out of 4,321 new car registrations in April the electric car models topped the list with 658 of these being the Tesla Model 3, and 367 coming from the Jaguar I Pace
  • Produce delivery company Milk & More had in excess of 25,000 new customers signing up at the beginning of lockdown

On 1 June it was announced that more than 200 top UK firms and investors have called upon the government to deliver a Covid-19 recovery plan that puts the environment first, and that ministers should use the lockdown as a springboard to a green economy. Signees of the initiative included ASDA, BNP Paribas, Greggs and Severn Trent, among many more. The proposals sent to the Prime Minister to include:

  • Driving new initiatives in low carbon innovation, infrastructure and industries
  • Focusing support on sectors that can best support the environment, increase job creation and foster the recovery – whilst also decarbonising the economy
  • Putting strings on financial support to ensure firms getting bailout cash are well managed, and in step with climate goals

Hopefully such movements are helping to encourage a way of life and business that supports more sustainable living. ESG investing should benefit from this as companies and funds with a stronger score and which lean towards ESG investing should benefit in performance.

What happened in the stock market?

Many commentators throughout the industry have asked whether ESG funds have performed better during Covid-19 and if so, why. ESG classification in the industry is still not clear cut but we can however look at which elements of the stock market that performed well and not so well over the last few months.1

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The above were some of the sectors that performed the worst during the last six months. Many of these sectors are excluded from ESG positive funds through a process called Negative Screening. Negative screening means purposefully eliminating sectors that more ESG conscious clients might wish to avoid. The three above sectors are some of those most often excluded through the negative screening approach, along with travel providers such as Carnival and EasyJet.

By removing these sectors from their investment strategies, many ESG funds immediately protected themselves from some of the largest and most negative knocks on the FTSE during the beginning of the Covid-19 pandemic.

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The above three sectors (if we expand ‘Offshore Wind’ to mean renewable energy) have performed well since Covid-19 hit. These are sectors that have been better protected due to their business models and their ability to continue business during these difficult times. Lots of pharmaceutical companies have seen share prices go up as a result of the increasing pressure and investment to produce a working vaccine for Covid-19. Technology companies have done well as many businesses and individuals have become reliant on technology in order to maintain some normality in everyday life, and to keep in touch with families and friends. Renewable energy companies have performed well because they are more agile than coal and oil industries, and consumers are looking towards more sustainable solutions.

There have been many that have performed above their benchmark, but here we'll take Baillie Gifford Positive Change and Janus Henderson Global Sustainable Equity as examples of ESG funds that have performed well during the Covid-19 outbreak.

The Baillie Gifford Positive Change fund was launched in January 2017 with the aim of investing 90% of its portfolios in companies whose products or behaviour have a positive impact on society. Within their top 10 holdings are companies like Tesla, Dexcom (pharmaceuticals) and Christian Hansen who work on natural ingredients for a number of sectors. In the last three months the fund has returned 17.7%, compared to its benchmark IA Global which has returned 3.9%. 

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Similarly, the Janus Henderson Global Sustainable Equity fund has performed well. The fund launched back in 1991 and looks to invest in companies (as judged by the fund manager) who are having a positive impact on society and/or the environment. Some of their top 10 holdings include Microsoft, Humana Inc. (a health and well-being company), and Autodesk (design software and services company). Once again by removing the negative screening sectors such as oil and tobacco and investing in sectors like technology and health care they have been able to perform well under Covid-19 conditions. In the last six months the fund has returned 11.3%, compared to the IA Global benchmark of 3.5%.

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ESG investing still has a long way to go, but now is a great time to engage in conversations with clients about this topic and what it means to them. The world has changed and we hope to continue to see people riding bikes, purchasing electric vehicles and looking to independent food suppliers once this is all over. Awareness is rising and with it will come increased competition in the market and more opportunity for great performance.

To switch or not to switch that is the question 

Thought-leadership piece from Adrian Boulding, Chief Innovation Officer of technology provider Spire Platform Solutions

Buy low - sell high is the objective of all speculators. But when it comes to pension plans, the buying takes place very gradually over a 40 year working life and the selling takes place almost equally slowly over a thirty year retirement.

Switching, on the other hand, is where the big decisions will lie in retirement planning. And switching is an altogether more complicated matter as it involves a decision to sell one investment and to buy a different investment both at the same time. Large sums of money may be involved, perhaps driven by client events – such as arriving at retirement date – or perhaps driven by market events – such as change in policy by the Bank of England.

This article invites advisers to consider whether one of those market moments has arisen as a result of the response to and fall out from Covid-19. It concentrates on clients in the early years of income drawdown, who probably have the largest amount of money invested they have ever had or will have going forward. So it could be a very large and significant switch.

I want to look mainly at the case for switching out of corporate bonds and into annuities. I’ll come back later in the piece and look at the argument for switching out of equities too, but I’m aware that in the main advisers had to spend March and April restraining clients whose natural response to free falling equity markets was to cry “get me out of here”, as selling at the bottom would have been a case of acting in haste and repenting at leisure.

Bonds have not been hit anything like as badly as equities by Covid-19. At the low point in March, while UK equities were 30% down since the start of the year, UK bonds, as measured by iBoxx all maturities index, were only 10% down, a loss they have since fully recovered. In part this is because the Bank of England, on 19th March, cut its base rate to 0.1%pa, the second cut they made in nine days of blind panic. For structural reasons, 0.1% is as low as the Bank can go, so we’ve hit rock bottom.

Outside of gilt edged stock, most corporate bonds are of fairly short duration, so their price is heavily influenced by a combination of today’s bank base rate and a market expectation of where that base rate will be over the next few years. And if base rate can’t go much further down, then bond values can’t go much further up.

But the case for switching out of corporate bonds is much stronger than an opinion on future interest rates. I’m talking about the unintended consequences of the movement that’s become known as “Build Back Better”. In all walks of life, I’m seeing a growing determination that as we return to normal from the Covid-19 lockdown, it will be not to the old normal, but to a new, better normal. More flexible working, shorter working hours, more exercise, wider pavements and cycle lanes, fewer emissions, just bring it on, the new normal will usher in changes as radical as society saw after the Great War of 1914-18

While some companies will prosper, others will fail when they either can’t or don’t adapt their business model to new normal conditions. For bondholders this is going to be an uncomfortably asymmetric experience. If the company they have invested does well, the bondholder continues to receive the promised low rate of coupon. But if the company flounders, then the bonds default and some or all of the investor’s capital is lost.

Wouldn’t it be nice if you could switch some of your client’s bonds into another investment that offered the low risk and predictability traditionally associated with bonds, but without that default risk? Amazingly there is an alternative to bonds that has these characteristics!

The humble annuity offers just this combination of certain returns and no default risk. An annuity is very bond-like, in that it promises a series of known payments on fixed dates. In fact it’s so bond-like that the insurance companies that issue annuities buy corporate bonds to back their annuities.

The great news about this switch – sell bonds, buy annuity – is that the default risk is passed from client to insurer. All that moaning about Solvency II that insurers made was because they have to hold levels of reserves that will keep them afloat even when their bonds default. And there’s a backstop beyond that too. In the highly unlikely event of an insurance company collapsing, the Financial Services Compensation Scheme will pay all the future annuity payments in full with no upper limit.

It’s looking through this long term lens that annuities outscore bonds. Typically the addition of an annuity to a client’s portfolio improves the stability of long term income. The flip side of that of course is that the portfolio value on early death available to your client’s heirs will be lower when bonds are switched to annuities.

Returning to equities, is it just too heretical to think of switching from equities to annuity? Factors that an adviser might like to consider in reviewing a client’s equity proportion include that equities have recovered somewhat from their direst lows back in March. Also there is an unseen danger – many firms have taken on huge additional debts to see them through the economic inactivity of lockdown and furlough, and there is pressure in the wings to have some of that debt turned into equity, a move that may reduce the stake of existing equity owners.

If you’ve come this far with me, then I’d ask two favours of you before your next client meeting. Go and get an annuity quote so you can see where rates are today, and think about where you would hold that annuity, either as a traditional stand-alone annuity or nestled inside your client’s flexi-access drawdown sipp.