There’s no doubt ethical investing is increasing in popularity but many think only of equities when searching for investments with a moral stance. Yet the number of ethical bond funds has increased since 2000 as asset managers broaden their ethical screens to this asset class.
F&C Ethical Bond and Standard Life Ethical Corporate Bond both carry Morningstar’s Standard ratings. We have no conviction in their ability to outperform long term, relative to conventional corporate bond funds. However, for investors determined to pursue ethical investing, these funds can be considered. But which one, if either, is right for you and your ethical stance?
People: Similar Experiences, But Different Teams
The managers of both funds have similar levels of experience. Alisdair Maclean at Standard Life has run his fund since its launch in 2005, having joined the firm in 2003. He is supported by an experienced team of 22, headed by Andrew Sutherland; the average tenure among members is eight years, showing it’s a cohesive group.
Rebecca Seabrook at F&C has also been in charge since the fund’s inception, although this fund was only launched in 2007. Seabrook has been a member of the team at F&C since 2001, when it was only three members strong--it is now over 25. The 11 members that are directly involved have an average tenure of just over three years at the firm. Seabrook is co-head of the team and, having helped to build it, she knows how to get the most from this resource. The team suffered departures in 2008 but these were primarily in the high yield area and things have since settled down.
We think Standard Life has the more stable team overall; the strength of the parent company means it hasn’t seen the same level of turnover as that at F&C.
Parent: The Benefits of Stability
The two firms are of a similar size when comparing assets under management. F&C managed nearly £100 billion as of December 2009, while Standard Life had around £139 billion.
F&C has had an uphill struggle in the last couple of years: parent company Friends Provident tried and failed to sell its majority stake in the firm in 2008 and this stake was subsequently distributed to shareholders. The firm was up for sale for some time, which took its toll, and a number of key personnel left the firm. On the bond team, there were departures on the high yield side. F&C is better positioned now, as the uncertainty of ownership is behind them, making for a more stable ship. But it will take time to regain its former strength.
Standard Life entered the credit crisis in a position of relative strength and the backing of the insurance company helped. A stable parent provides several benefits to fund investors, not least continuity of management. The firm committed to expanding resources despite the downturn in the markets and has even started the process of establishing a US office for the team, headed by Erlend Lochen.
We believe Standard Life has been the more stable parent over the recent past and this stability is reflected by the commitment of the team to the firm.
Process: How Ethical is Ethical?
The first thing to consider is the ethical screens used at each fund, as this is the driving force behind returns. Both firms have detailed descriptions of what they view as positive and negative criteria on their web sites, although we think access to both could be a little easier. They share some views: for example, neither fund will invest in companies involved in the sale of alcohol or pornography. But the main difference is how much they will allow investment in financials as these comprise over 30% of the UK corporate bond universe. So that alone will have a big impact on performance.
The Standard Life fund is prevented from owning most financials, though certain banks are permitted. While we don’t have a clear list of which financials are excluded, by using our data to compare this fund with Standard Life Corporate Bond, Barclays and Bank of America are permitted but not Abu Dhabi Commercial Bank, for example. Standard Life set their ethical guidelines by canvassing investors’ and intermediaries’ opinions. This is done annually so in theory these could change. In practice, we think such changes are likely to be at the margin, but investors considering this fund should take on board the fact the ethical criteria can change annually, so they should make regular checks to ensure their views are still aligned.
F&C has an ethical committee comprising experts in different fields who are responsible for deciding which companies meet their ethical criteria. Unlike at Standard Life, most financials are permissible investments and have been since 2007. In fact, Seabrook believed this was important for the viability of the fund, so it was only launched once the Stewardship committee sanctioned the purchase of financials. She felt that, without financials, the restrictions were too high to be able to run a fund well for investors. The committee re-assessed their financials list in late 2009 after the market meltdown and only UBS was taken off the list. F&C has been investing in the ethical space for a considerable length of time, albeit on the equity side of the business, and we think their expert committee is well established and robust.
Ultimately, though, your choice of fund is determined by your view on the banks. If you think most banks don’t qualify as ethical investments, then Standard Life is the fund for you. If you want to give yourself a fighting chance, given the dominance of the sector in the corporate bond space, then F&C appears to have more diversification in the range of financials they can hold. Either way, we think both managers have their hands tied behind their backs as the restrictions will limit their competitiveness against broader corporate bond funds.
Performance: Why Restrictions Matter
The restrictions on these funds will result in performance that is very different from the average peer in the Morningstar Sterling Corporate bond category but their stance on banks will also make a difference.
Both funds were top quartile during 2008. The inability to hold most financials helped Maclean in 2007 when the credit crisis set in, and the impact carried through to 2008--though it lost 2.61% in absolute terms that year, this was 5.26 percentage points better than the category average. The fund can’t hold UK gilts either and thus did not benefit from their strong performance in 2008. In 2009, Maclean couldn’t fully participate in the rally in financials and was bottom quartile, but he was less than three percentage points behind the F&C fund--a surprising result.
As F&C only launched their fund in 2007, it was an easy decision to avoid most financials, despite being allowed to invest in the sector. This stance paid off well in 2008 and the fund lost just 79 basis points, compared with the average category loss of nearly 8%. But 2009 was a disappointment--Seabrook kept a defensive position and still had an underweight in financials in the fourth quarter. We think performance should have been better than it was, given her ability to hold banks, although we wouldn’t expect it to match the category average.
These results show that financials will be a big determinant of performance for these funds. Top-down positioning also plays a role though, as shown at F&C in 2009--a disappointment as we would have expected a bigger divergence given their difference stances on the sector.
Price: Ethics Come at a Cost
The funds’ total expense ratios differ by just 4 basis points so there is little to differentiate them here, but both are notably higher than the category median. Expenses are very important in bond funds, as returns are tightly constrained, and the ethical restrictions are a further hindrance. Standard Life Ethical Corporate Bond has higher turnover, too, and trading costs could eat further into returns.
Which Fund is Right for You?
The ethical constraints in both funds will result in performance that differs considerably from mainstream corporate bond funds. We think the choice between these two funds comes down to your view on banks. If you think the banks’ behaviour isn’t in keeping with your ethical stance, then Standard Life is the more suitable fund. If you’re prepared to hold banks--and don’t want to cut out nearly 30% of your investible universe (before the ethical screens are applied on top of this)--then F&C offers greater diversification, though it is disappointing that it underperformed in 2009 despite the greater flexibility.
