Ethical Investing 

Best in Class: Mixing income with ethics

Best in Class: Mixing income with ethics

Good Money Week runs from October 30 to November 5 and raises awareness that sustainable and ethical options can have a positive impact on society without sacrificing financial performance.

So it seems apt that, this week, I highlight the Rathbone Ethical Bond fund. 

Sitting in the IA Sterling Corporate Bond sector, it invests in quality investment grade bonds and has had one of the highest yields among its peers (currently 4.6 per cent). For an income investor wanting to save responsibly it could be a good core fixed income holding.

The fund’s ethical exclusions are simple: no mining, arms, gambling, pornography, animal testing, nuclear power, alcohol or tobacco companies – which rules out about one-third of the index. It doesn’t invest in UK government debt because of the nation’s arms trade. Also, all positions must have at least one positive environmental, social or corporate governance (ESG) aspect.

This fund typifies stable management, with Bryn Jones having run it for 12 years. He manages the fund with a four-step investment process. Idea generation comes first. This is followed by a ‘four Cs plus’ approach to credit quality assessment: character, capacity, collateral and covenants. Relative valuations are considered in the penultimate step. The ethical screen is applied as the final stage. Mr Jones will then invest with conviction, holding a decent position in bonds he likes and zero in those he doesn’t.

The risk profile for this fund is average relative to its sector, but Mr Jones stresses it is not low risk. In his own words: “It is not a diversification from equities, or somewhere to hide if things get nasty.” 

As a surrogate for gilts, Mr Jones buys European Investment Bank (EIB) bonds, but has recently chosen to buy higher yielding debt that matures earlier. This has given the portfolio a much lower duration, or interest rate sensitivity. These bonds have lower credit ratings than gilts and EIB bonds, so he is taking more risk. But, as he points out, buying gilts above their face value at minuscule yields offers risks of its own.

This stance has paid off well in the past few months. The 10-year gilt yield has shot up from 0.64 per cent at the end of August to above 1.1 per cent on fears of higher inflation. Because the fund is underweight duration, it has done much better than its peers over this short period. 

For some time now Mr Jones has also been overweight UK subordinated financial names. These bonds offer higher yields that help to protect the fund from rising interest rates. He believes the compounding effects of the higher income from coupons will protect the portfolio as rates rise. This should offer greater returns over the medium to long term, albeit with some short-term volatility. He likes UK financials because regulators have forced them to recapitalise. Also, banks are helped by the Bank of England’s term funding scheme, giving them cheap money to lend to the real economy.