Ethical portfolio strong in face of Covid

Oil industry pain has been a tailwind for the Money Observer portfolio, with ESG funds looking well placed for the ‘new normal’.

The past three months have been an extraordinary period for all of us, with ramifications that go far beyond investment markets. The sheer scale of what has happened is staggering, from unemployment claims in the US to mass furloughing in the UK, the hundreds of billions of pounds pledged by the chancellor to bolster the economy, and the trillions of dollars of US Federal Reserve support. The extremes we are witnessing are far beyond the experiences of the global financial crisis just over a decade ago.

However, markets remain open and functioning, with the immediate panic and heightened asset class correlations having eased noticeably. Against that backdrop, how have our selections fared?

Pleasingly, the portfolio has been more resilient than the benchmark. It is easy to forget that before the coronavirus fears escalated, the oil war launched by Saudi Arabia in response to Russia’s refusal to cut production triggered a supply shock that decimated the oil price and oil-related companies on the back of it. This has undoubtedly been a tailwind for our selections, given their general focus on investing in solutions to climate change as opposed to its causes, but it is by no means the only source of strength.

Since our last update the portfolio has returned -5.6% while its benchmark, the IA mixed investment 40-85% shares sector, has returned -8.9%.

UK equities underperformed global equities over the period, in part due to currency effects, but both the Liontrust Sustainable Future UK Growth fund and our own Castlefield B.E.S.T Sustainable Smaller Companies outperformed the wider UK market, returning -14% and -16.8% respectively versus the FTSE All-Share’s -20.6%.

Liontrust points to performance being supported by its healthcare themes, as well as its digital technology-related themes as millions face working remotely for the foreseeable future.

Stocks in similar sectors were key performers in the Castlefield fund, with manufacturer of contamination control products Tristel a notable performer. As well as selectively adding to current names from cash, we took advantage of market moves to initiate three new positions, of which two were in healthcare-related sectors and the third in technology.

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Strong global rally

Global equities rallied much more strongly than the UK market after the initial sell-off, with the FTSE World index returning -9.8%. Returns from our selected funds were mixed, with Liontrust Sustainable Future Global Growth returning -1% for the period and Stewart Investors Worldwide Sustainabilitynot far behind at -1.4%, both well ahead of the IA Global sector and the FTSE World index.

WHEB Sustainability also outperformed, returning -5.8%, but Sarasin Food & Agriculture Opportunities continued to lag, returning -13%.

Liontrust, again following the Sustainable Future investment process seen in the UK growth fund, pointed to the outperformance from stocks in healthcare and technology sectors. The Stewart fund differs from the Liontrust global fund most notably through its geographical allocation, as it typically has less exposure to the US and more in Australia and Asia. The US and Asia have been two regions where equity markets have recovered most strongly from the lows seen in mid-March, so these funds have demonstrated similar performance.

Stewart Investors also took advantage of lower valuations and initiated three positions where previously the ESG (environment, social and governance) credentials came at too high a market price.

WHEB’s outperformance is attributed in part to its avoidance of energy and financial stocks. The fund’s sustainable transport theme struggled during the market tumult as, despite their strong conviction in the transition to electric vehicles, such holdings remain sensitive to the overall volumes of car sales, where coronavirus has had a devastating impact.

The Sarasin fund has continued to give back previous gains in recent months, unsurprisingly so given the impact seen across the food supply chain. While some retailers such as supermarkets have held up well as people focus on the essentials, those businesses that are not customer-facing have experienced labour shortages, fluctuating agricultural commodity prices and logistical issues. However, we expect the team to be adept at positioning the fund for any emerging structural changes in the food and agriculture economy.

Power prices impact

Our other non-equity pick, Greencoat UK Wind, was down -3.9% by 1 May, having taken something of a round trip in share price terms. Along with its renewable infrastructure peers, it was affected by power prices falling as a result of the oil war, leading to its net asset value (NAV) being marked down slightly. However, the share price fall far outweighed the actual NAV impact, and as markets stabilised the shares recovered accordingly.

The premium to NAV has reduced and this reflects two key attractions. First, that the business model is reliable regardless of the impact of Covid-19, something underlined by the recent acquisition of a Scottish wind farm of 50 turbines for £320 million to continue growing the asset base. Secondly, its dividend payout remains comfortably covered by cash generation and is not subject to the dividend cuts seen elsewhere in the UK market. Against that backdrop of income pressure, the company’s payout brings increased attractions.

Moving to bonds, the Royal London Ethical Bond Fund returned -3% while the Rathbone Ethical Bond Fundwas down -3.4%. Often viewed as ‘safe haven’ assets, bonds were also caught up in the wider market volatility. In part, the defensive nature of fixed income assets has come through as expected, with government bonds rising in price as central banks cut interest rates and provided extensive support packages. However, concerns about the effect of global lockdown on corporate revenues and potential defaults saw credit risk affect returns, with spreads widening and yields rising.

The Royal London fund outperformed over the period, overcoming its lower allocation to supranational issues (which have performed strongly) by a greater allocation to issues from investment trusts and social housing. The fund also has lower exposure to some of the most impacted sectors, such as leisure, energy and travel.

So where do we go from here? Markets have been steadily recovering and yet there remains a disconnect between the economic reality of a significant rise in unemployment and continued disruption to business, and stock markets not hugely far removed from all-time highs.

To date the latter have been cheered by the support measures, particularly from the Fed, and so have responded with an optimistic assessment of the outlook. But we wonder whether the reality is more uncertain. On balance, it seems that hope is in the ascendance over reality at present.

Ramifications

Elsewhere, many commentators have focused on the crisis as a springboard for even wider adoption of ESG considerations. It is easy to see the impact of global lockdowns in much-improved air quality, and in one sense we now have a very real demonstration of what can be achieved in tackling a global crisis. However, experience suggests we must wait and see whether the political will exists to up the ante here.

More than anything, our sense is that we are on the cusp of a surge in the ‘social’ element of ESG considerations. We have been assessing how companies responded to the crisis. It seems fair that government support be given in exchange for company commitments such as on fair pay and tax contributions. Our expectation is that our selections are focused on these areas as part of identifying long-term sustainability, and accordingly we expect them to continue to perform well, whatever the ‘new normal’ looks like.

ESG portfolio has proved more robust than the benchmark in downturn

Source: Castlefield, as at 1 May 2020