Combining ethics with high returns

Exposure to the covered bond sector, a relatively new market for sterling corporate bonds, has helped boost performance of the £124.28m Royal London Ethical Bond fund.

Covered bonds are senior debt issued by financial firms and backed by a specific pool of assets from the issuer. As such, they are tied up with the financial sector, but their asset backing has provided an additional measure of security following the financial crisis.

The fund’s largest weighting to an industry sector is in banks and financial services, at 20.5 per cent of the portfolio, slightly below the weighting of 21 per cent in its benchmark index. However, it has 8.2 per cent in covered bonds compared with the index’s 2.9 per cent holding.

Fund manager Eric Holt says: “It’s a pretty new market within sterling assets, [but] it’s been around in Europe for donkey’s years. It provided an entry for the banks to come back to the bond market in a time when there was a degree of challenge for raising finance for the sector.

“But from a market that didn’t exist a couple of years ago, we’ve got just above 8 per cent of the fund in that sector, and in recent months they’ve performed really well. That illustrates how we can be opportunistic. We’re way above benchmark weightings in the sector and the fundamental value that we expect to come through over time in this instance has come through pretty quick.”

The fund has an ethical bias, avoiding areas such as alcohol, armaments, gambling, pornography, tobacco, human rights infringers, animal testing and firms whose activities damage the environment. However, the manager notes it isn’t at the ‘deep green’ end of the ethical spectrum.

“It is not targeting things that are specifically environmentally orientated, but equally the ethos of the fund is towards those socially responsible areas that we believe correspond to our investor base,” Mr Holt says.

Although the fund uses external ethical research firm Eiris to validate its investments, Mr Holt notes the manner in which it invests is very much in line with Royal London Asset Management’s overall process and what it sees as the attractive characteristics within corporate bonds. The portfolio is diverse, with approximately 250 holdings. “It’s not all about getting one investment right,” says Mr Holt. “We want to protect the downside of investments where we can, so if we can get a claim on assets or on cashflow we think that really supports the quality of the investment, because if you can combine that with an attractive yield it seems to be a really sweet spot.

“We have a benchmark for the fund but we don’t slavishly follow that, certainly on sector distribution, so we do take some positive views where there is value.”