11/02/2008
Ethical Corporate Bonds – Principal or Principles? | Investment Week - 11th February 2008
Only a few years ago anyone who wanted to invest their money ethically had a fairly limited range of options, with little choice of funds outside the realm of UK equities. However, investors’ keenness to diversify their holdings while continuing to invest their money ethically has resulted in the creation of numerous ethical funds for UK investors that are broader both in geographical scope and in terms of asset class.
The growth in the market for ethical corporate bond funds has been underpinned by the increasing number of ethically-minded investors reaching a stage in life where basic financial planning suggests a reduction in the risk profile of their portfolio of investments as they approach retirement.
Investors considering making an ethical investment need to understand that the definition of ‘ethical’ varies.
Consequently different fund managers apply different sets of criteria in determining the investments that may be held by their ethical funds. Typically these are also subject to change over time as new issues (e.g. climate change) become more central to investors’ perception of what constitutes an ethical investment. Before buying a product investors should investigate the ethical investment policy that will govern the fund in which they are planning to invest to ensure a good fit with their own opinions on particular issues including but not limited to animal testing, environmental pollution, human rights, intensive farming, nuclear power, tobacco manufacturing and the arms industry.
The process of managing an ethical fund should in most cases be very similar to that of managing any other type of fund. All of the same valuation techniques apply, the sole difference being that certain sectors or individual companies must be excluded from the fund’s holdings. As a result, the commonality of holdings between an ethical fund and an otherwise similar but ethically unconstrained fund should typically be high if it is driven by the same fundamental investment process. Looking specifically at the management of bond funds, the average rating and the duration positioning of a fund should not be particularly influenced by whether a fund is run according to ethical criteria unless, for example, the fund manager wishes to increase exposure to AAA bonds but has too few AAA-rated bonds that meet his or her ethical criteria for the execution of the strategy to be possible.
As the quantum of funds run according to ethical criteria has increased, so too though has the number of bond and share investment opportunities that have been structured to attract interest from this specialist market. The renewable energy market in particular has seen a number of companies set up to develop renewable energy from a variety of sources and they have in many cases sought investment from ethical funds. Looking specifically at bond investment opportunities in the sector, there have been a number of issues involving the securitisation of future revenues from wind farms in continental Europe under the appropriate entity name of Breeze.
It needs to be made abundantly clear, however, that a successful ethical investment is not a charitable donation and must never be regarded as such. In just the same way as with mainstream funds, investors in ethical funds are trying to achieve principal appreciation and/or income. The ethical fund manager’s role is to do all that they can to limit any negative impact on the returns achieved by investors from the investment restrictions imposed on the fund by its ethical policy.
Another example of a bond with good ethical credentials that also stacks up as an attractive investment is the GAVI Alliance’s AAA-rated bond issue in November 2006. This bond provides the funding for health workers in developing nations to get on with the hugely valuable work of vaccinating children against diseases such as Yellow Fever and Measles supported by the pledges of future aid from donor governments. However, setting the ethical dimension to one side for a moment, a key attraction from a bond fund manager’s point of view has been its AAA rating, which has enabled it to weather the risk adverse markets of the last few months much better than lower-rated bonds.
The area of microfinance, the business of making very small loans to individuals and small co-operatives in developing nations to enable them to start or expand small businesses, is also one that has attracted the attention of ethical corporate bond investors. There have been several securitisations of loans to microfinance institutions (MFIs), which operate like small banks and make the decision as to whether to lend money to individual borrowers. From a pure credit point of view, the attraction of the bonds has been the way in which the structure provides two levels of diversification which should minimise the potential for losses. In the first place, the individual loans that an MFI is making tend to be very small (say below $100 in many cases) and although concentrated in one geographical area, would ideally be to a variety of different industries such as carpentry, fishing or small market stalls preparing food. At the next level up, though, the bond issue should provide exposure to MFIs across a variety of geographically diverse nations across the developing world to limit the potential for an economic crisis in one nation to wipe out the value of the bond, for example if the Colombian peso were to devalue.
When all is said and done, the fundamental aim of ethical funds is to enable investors to feel that they have not had to sacrifice their principles in order to achieve attractive returns on their principal.
Alasdair MacLean, Manager of the Ethical Corporate Bond Fund at Standard Life Investments.
This article was published in Investment Week on 11th February 2008
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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