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DFMs' first-half scorecards make for rosy reading; The rise of sustainable self-certification

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Halfway house

The first six months of the year can be summed up succinctly in performance terms: virtually all bond sectors are in the red, and everything else is in the black.

That conclusion’s from the point of view of a sterling-based investor looking at the Investment Association sectors. And there are now many more of those groupings, following the IA’s recent decision to divide up its bond categories.

That means 22 bond sectors in total: of these, 18 have posted losses in the first half, barring a big recovery over the next couple of days. Currency is a factor in some cases, but UK gilt funds’ average 6.3 per cent loss speaks for itself.

The exceptions are the more equity-like groups: the strategic bond sector has returned 0.4 per cent on average, and the three high-yield sectors have made between 2 and 3 per cent each.

We’ve spoken about HY resilience on a number of occasions this year; for all that strength, wealth managers are content to continue to take exposure via their strat bond picks.

Regular investment grade corporate bond funds, on the other hand, are more typically found in wealth portfolios. Here, performance has been less healthy – unsurprisingly so, given the way that government bond yields moved in the wrong direction at the start of the year.

But as spreads continue to tighten, some commentators see cause for optimism nonetheless. Bloomberg notes that managers at BMO suggest US spreads could tighten further from their current 14-year lows. All of which is to say: for all the talk of inflation, DFMs’ preference for credit is still shared by many other market participants at the moment.

Reformed or rebadged?

The sustainable fund flow boom is increasingly making itself felt in the fixed income arena. The FT reports that $54bn was invested in ESG bond funds across the globe in the first five months of the year, compared with $68bn for the whole of 2020.

Passive strategies are a decent part of that: $17bn of net flows so far this year versus $15.6bn last year, per Morningstar figures provided to the paper.

Launches aren’t quite on the same upwards trend, though an acceleration is visible here, too: 44 in the first quarter of the year, compared with 122 new ESG bond funds in 2021.

That in itself may point to the level of rebranding going on in the industry, as providers rush to prove they’re sustainable, or at the very least sustainable-adjacent.

Other Morningstar data highlights this point: judge fund flows (across all asset classes) by their sustainability scores, and there is a preference for those the provider ranks 4 or 5. That said, the group of funds it doesn’t currently rate by this metric have also seen healthy flows so far this year.

Refer to funds’ own designations, however, and the gap is more distinct.

Products categorised as a “sustainable fund by prospectus” – ie those that have a declared sustainable mandate – have taken in £18.6bn so far this year. Those that don't have shed £7.1bn. Whether this is a reflection of investor interest, or in part due to providers scrabbling to ensure their popular products are seen to be toeing the ESG line, is still up for debate.

Pressure to perform

Slowly but surely, performance fees in Europe are falling into line with regulatory requirements. Research from Fitz Partners has found 88 per cent of Irish and Luxembourg-domiciled funds now use a crystallisation period of 12 months or more, while 72 per cent of fee structures now measure “true outperformance against an external benchmark”.

That’s in keeping with guidelines from the European Securities and Market Authority which, among other things, require funds to have in place either a five-year high watermark or a clawback structure. Those rules are already in place in Ireland; funds in Luxembourg have until their first post-July accounting date to conform. Consistency will be welcomed by fund selectors: UK strategies don’t have to abide by these rules but may find they become standard practice nonetheless.

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