Baptism of fire By Francois de Bruin, Aviva Investors 06 Oct 2020
A little more than a year after the launch of the Sustainable Investment and Growth Fund, this seems an appropriate moment to reflect on what has been a fairly momentous period for economies and financial markets.
One year ago, we embarked on an ambitious journey to deliver three important outcomes:
We knew if we were to have any hope of being successful, we had to look and behave different to traditional multi asset income funds. This led to a bottom-up investment approach unconstrained by style or asset class, save for the rigour pertaining to our ESG criteria. An avant-garde fund made possible through the power of connected thinking.
“No fund manager is an island”; in my case, I am lucky to draw on the resources of our equities, credit, multi-asset, real assets and solutions teams. This fund is made possible through the power of connected thinking.
When we launched the strategy in July 2019, we knew the journey ahead would be difficult. US-China trade tensions coupled with lofty aggregate valuations in both fixed income and equity markets put an acute emphasis on security selection.
By mid-February, we had delivered a total return close to eight per cent, and our cautious stance resulted in credit representing almost half (47 per cent) of our total allocation, with real assets a further 24 per cent; we were already preparing for a drought by irrigating our trenches. Yet with the benefit of hindsight, we should have been preparing for a flood. None of our scenario analysis or risk management tools could have fully prepared us for a global pandemic, lockdowns and the near total collapse of activity in many industries.
Baptism of Fire As the fiercest recession since the Great Depression ensued, we went from a positive return to down 26 per cent in just over a month. Exposure to property, which proved so resilient in the most recent sell-off in 2018, now worked against us as airports and city doors were shuttered, underperforming equities by 14 per cent.
While our baptism of fire was not ideal, it at least gave us an opportunity to prove our concept. By focusing on companies with sustainable business models and cash flows, you don’t have to worry so much about capital volatility as much because you can take the natural income to meet your near-term goals, while leaving your capital in place to grow over the long term. But in this challenging environment, it is important to consider the outlook for each of the three outcomes SIG is focused on.
Income investing With dividend cuts, historically low yields, rising corporate defaults and an uncertain property market, some investors have started to question whether income investing is dead. Heightened uncertainty and aggregate global bond yields languishing below one per cent make this a fair question.
While the uncertainty means income investing is harder, low yields also means it is more important. Despite the headline reduction across markets, we have delivered our five per cent income objective and remain on track to do so. There are 3044 companies in the MSCI ACWI Index, of which 2114 paid dividends in 2019. In 2020, 16 per cent are expected to cut dividends, of which five per cent will omit dividends completely according to Bloomberg. SIG only holds 64 securities, which affords us the flexibility to navigate this uncertainty.
Sustainability As a long-only fund, we do not rely on derivatives to manage near-term risks. Our global remit means we rely on natural diversification benefits to balance exposures. During a crisis, we do not expect these diversification benefits to hold as correlations tend to one as the market rushes for liquidity. Instead, as a risk management tool we rely on careful consideration of the fundamental drivers of cash flows for our holdings.
Bank of America research showed that from 2005 to 2015 seventeen companies went bankrupt on the S&P 500. Fifteen of those companies had ESG scores that were below average. With the lowest rated 20 per cent excluded from our universe, and an average ESG Elements1 score significantly higher than the market, it gave us confidence the performance would recover once near-term technical factors give way to long-term fundamentals.
Growth After one year, it is too difficult to successfully measure whether the fund will meet its objectives of long-term capital growth. It is our fundamental belief that capital growth is a function of income growth over time. Over short-term time horizons, capital returns are largely a function of changing investor preferences and multiples. Nevertheless, given the enormity of events over the past year, a return of -3.5 per cent since inception puts us in a strong position to deliver our objective of long-term growth.
Encouragingly, we have demonstrated for most of the period that the fund has the propensity for capital growth, capturing 69 per cent of the upside in global equities between August 5, 2019 and February 14, 2020, a return of 11.7 per cent; and another 78 per cent from the lows on March 23 to June 8, equivalent to 33.1 per cent. In contrast, we saw a 48 per cent impact from the five per cent correction in July last year, and 32 per cent of the downside in June this year. It was the lockdown anomaly that cost us, suffering a 95 per cent impact from the global equity drawdown.
The second informative trait for growth is our ability to be contrarian. As equity valuations became expensive, we reduced our allocation to its lowest weighting (28 per cent) at the end of January. As the market crash reached its nadir on March 23, we increased our equity allocation to 40 per cent and reduced our credit allocation to 36 per, their highest and lowest weights respectively over the past year. We believe a process that encourages uncomfortable but disciplined risk taking is likely to produce better than average results long term.
Our unconstrained approach also allows us to acknowledge that this crisis has accelerated structural changes. As a result, we have significantly changed the composition of the portfolio by selling holdings related to retail, student accommodation, oil, banks and southern emerging market nations. Instead, we have looked to capture opportunities on the right side of change ranging from life sciences and healthcare, to work from home beneficiaries and the migration to digital.
Where possible, we have also looked for revenue streams backed by the US federal government or improved credit quality and, taking the lead from our emerging market teams, have looked for investments in north Asia. While the monetary and fiscal policy backdrop remains supportive for growth assets long-term, we acknowledge deep-seated tail risks and continue to favour less cyclical companies.
In summary, it has been a truly remarkable year. But as we move from resilience to renaissance, there are exciting times in front of us.
Thank you again for your support over the past year. It is greatly appreciated.
Best regards, Francois
1 Our proprietary ESG Elements score is a company-specific integration tool. It includes a range of material ESG data sources and analysis, including our internal governance rating, which is based on historic voting records. Our score draws together a wide range of metrics including those provided by MSCI. It is based on both external ESG data providers combined with internal ESG research including our own assessments of a company’s ESG practices (through monitoring and engagement), which are also recorded in our in-house database. We use our score and database to help identify investment risk and opportunities within the investment universe to inform decisions in the portfolio construction phase.
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