Bryn Jones, manager of the £1.2bn Ethical Bond fund, said the team runs the portfolio with a strict ethical and financial criteria.
Therefore, the fund does not invest in government bonds, because of governments' propensity to borrow money that will be spent in areas such as defence or nuclear power, which many ethical investors would want to avoid.
He said: "We actively avoid government bonds as many governments borrow money to finance areas that are part of our initial negative screening. Primarily, this is nuclear power and weapons, but not limited to these factors.
"For us, where our base currency is GBP, this means we do not invest in gilts."
Mr Jones said this meant the team does not invest in other government bonds, adding: "this has protected us to a certain extent from investing in riskier areas such as emerging market government debt or peripheral government debt".
As a result of avoiding areas of high risk, thanks to the ethical criteria, the income-generating fund, which aims for a gross interest yield of between 5 per cent and 7 per cent, has benefited from its anti-sovereign bond stance.
Data from Financial Express, to 31 May, shows the fund has outperformed peers in the Investment Association Sterling Corporate Bond sector over the past one, three and five years, returning 1.62 per cent, 13.63 per cent and 28.27 per cent over those time periods, compared with minus 0.15 per cent, 11.15 per cent and 21.4 per cent respectively for the sector.
Government bonds form a backbone of many portfolios and are hard to replace with other investments. Neil AdamsMr Jones added: "It is worth mentioning that we invest in higher yielding assets as a result of not investing in gilts.
"We hope that all our strong macro, credit and valuation work, and ethical screening processes support this, which means we can generate excess returns over and above government bond markets, and over a three to five-year investment horizon."
According to Mr Jones, extra carry also generates more return over the life of the bond fund. He explained: "Due to our processes of investing where we see value, neither are we forced to hold extra long duration assets for no extra yield either, something that is highly prevalent in the long end of the Gilt market.
"The long end of the bond market is artificially expensive due to demand/supply imbalances created by pension and life funds. We don’t have to fish in this pond where Sharpe ratios can be very low."
Neil Adams, pensions and investment specialist advice firm Drewberry, said: “There have been equity/managed funds that allow ethical investments for some time now, but with bonds the opportunities are much narrower.
"However, government bonds form a backbone of many portfolios and are hard to replace with other investments when it comes to security and stability and without taking an unacceptable level of risk. In addition gilts are the underlying asset for annuities."
According to Mr Adams, ethical investors still face a restricted marketplace and having a diversified portfolio becomes more difficult.
He added: "The main factor with ethical investing is that it’s not up to the investment manager or adviser to say what’s ethical – it’s a morality issue that’s down to the investor themselves.
"What one investor may deem ethical another may not, so it takes careful work with an individual to build a portfolio that’s truly ethical for them."
Find out more
To understand how investors can benefit from integrating CSR into their portfolios, read FTAdviser's CPD guide, which qualifies for an indicative 60 minutes' worth of CPD.
simoney.kyriakou@ft.com
