Sustainable, Responsible &/or ESG Policy:
RLAM’s ethical framework combines the avoidance of companies involved in excluded activities with the identification of best of breed companies in permitted sectors. Companies that generate over 10% of their turnover from either one or a combination of the following categories are excluded:
- Armaments manufacturing armaments or nuclear weapons, or associated strategic products.
- Tobacco growing, processing or selling tobacco products.
If a company breaches this threshold, then it is likely that that company’s involvement in that excluded sector is a noteworthy part of their business and strategy.
Also, this threshold is deemed to be realistic and appropriate in terms of assessing a company, given that it may not be possible to always pinpoint the exact turnover derived from an excluded activity. This threshold ensures that a minimum of 90% of each holding meets the ethical criteria.
Sustainable, Responsible &/or ESG Process:
RLAM has established and maintained a commendable reputation over the last two decades as a high quality, active fixed income manager. Our long-standing philosophy and process have been central to our success and consistent record of outperformance.
The three objectives of RLAM’s credit process are:
- To exploit market inefficiencies and identify mis-priced credit risk – based on a belief that the market undervalues genuine credit enhancements, over-values more superficial credit characteristics and that the methodologies employed by rating agencies are too narrow and rigid;
- To ensure appropriate research coverage to identify and manage specific risks in portfolios; this leads to a high exposure to secured debt; and
- To ensure our funds are diversified without significant sector or issuer concentrations.
The central pillars of our investment approach which enable us to achieve these objectives are:
- A targeted allocation of resource
- Focuses primary research (financial modelling and the derivation of financial data) on untapped and under-researched areas; targeting of primary research will be a function of both the opportunity to add value (scale, profile and third party coverage of an issuer) and potential financial risk. The nature of our universe, with a high proportion of large cap issuers, releases our analysts to focus primary analysis on genuine market inefficiencies.
- Never duplicates third party research if it cannot be enhanced.
- Never delegates the final evaluation; whether information is being internally or externally derived, given our very different philosophical approach to valuation, we will never delegate the final decision as to whether a bond is selected in our portfolios.
- A focus on sustainability of opening lender position
- We are aware that volatility is damaging for providers of fixed capital and the risk profile of credit is asymmetric (bonds have capped upside – they do not participate in the profit growth of a company – but full exposure to capital loss).
- We focus on fundamental factors that genuinely impact creditors.
- We place most emphasis on the highest conviction characteristics of corporate bonds e.g. covenants, structure and security.
- Encouraging a collegiate approach to research
- Team-wide decision making; maintaining a team of experienced credit specialists with contrasting and complementary knowledge and skills, sharing a common philosophy and incentives.
- Overlapped sector coverage (ABS and unsecured); this ensures analysts have a more rounded sense of valuation to bring to their discussions with the rest of the team and increases team-wide scrutiny.
- Dynamic interaction and prompt evaluation; maintaining an appropriate team size that avoids unnecessary bureaucracy and fragmented decision making.
While issuer type will determine the specific nature of the research undertaken and the balance of the analysis, RLAM has a long established framework for evaluating ‘overall’ credit risk. At the heart of this approach is producing ‘relevant’ corporate analysis. We do not over-emphasise short-term trends or news flow and do not produce research simply to demonstrate the breadth of our capabilities. We feel this merely adds to the mountain of research that is already produced externally across large swathes of a credit market that is dominated by large issuers. It does mean focusing on how we can add value through our research and a consideration of factors that are relevant to long-term lenders rather than traders.
Our focus is on creating robust portfolios that will deliver long-term returns in a low risk way. The core of our approach is therefore to concentrate upon the most reliable sources of outperformance.
Sector and security selection: Our philosophy is to look where others are not looking as the best way of creating diversified and robust credit portfolios. This means emphasis on bond covenant analysis and attention to the security offered by a particular bond.
Duration: Positioning is a key determinant of performance. We manage the duration of the portfolio to reflect our views on long-term interest rates. Our style is to back our views but to ensure that the scale of the duration position is appropriate.
Asset allocation: This can be a source of outperformance; we are prepared to be different from the consensus.
Yield curve: Positioning will be used to enhance return. We undertake various yield curve trades within the different segments of the portfolio while controlling overall duration.
Over the longer term, we believe that sector and security selection will be the most important component of outperformance and that the contribution to performance of other factors will vary depending on market conditions.
By emphasising a longer term investment horizon, RLAM seeks to ensure that our clients we are adequately paid for overall credit risk without an assumed safety net of constant liquidity. However, we also believe that our tested philosophy and processes, combined with an efficient team structure, provides an exceptionally solid foundation to exploit short-term valuation anomalies when these present themselves. This is very distinct from an overall strategy that is dependent on lower conviction trading to generate sustainable returns.
Ethical overlay
Our ethical investment process begins with screening for eligible investments, which is conducted by our in-house team of experts using specialist research from MSCI ESG Research and Glass Lewis. Our in-house team has extensive knowledge of environmental, social and governance (ESG) issues and has created a bespoke approach to assessing ESG from a credit perspective. RLAM’s ethical framework combines the avoidance of companies involved in excluded activities with the identification of best of breed companies in permitted sectors and integration of material ESG issues into investment decision-making.
Companies that generate over 10% of their turnover from either one or a combination of the following categories are excluded:
- Armaments manufacturing armaments or nuclear weapons, or associated strategic products; or
- Tobacco growing, processing or selling tobacco products.
If a company breaches this threshold, then it is likely that that company’s involvement in that excluded sector is a noteworthy part of their business and strategy.
Also, this threshold is deemed to be realistic and appropriate in terms of assessing a company, given that it may not be possible to always pinpoint the exact turnover derived from an excluded activity. This threshold ensures that a minimum of 90% of each holding meets the ethical criteria.
There is no static list of firms and organisations eligible for investment by the fund. The ethical criteria screening process is ongoing and implemented pre-trade as part of the rigorous RLAM in-house credit analysis process coupled with independent ethical screening of issuing companies (and other companies that we request ad hoc) carried out by MSCI. As per all of RLAM’s unit funds, weekly, the fund managers will sign off on the portfolio construction certifying that it adheres to the investment and borrowing powers as set out in the prospectus, and the Royal London Unit Trust Managers (RLUTM) Executive Committee will review the ethical criteria themselves on a quarterly basis.
We integrate ESG into our credit analysis as we principally see ourselves as long-term lenders of our clients’ money rather than short-term traders of bonds. The sustainability of our lending position is, therefore, critical and we tailor our approach both to the specifics of fixed income investing, reflecting the asymmetric nature of credit risk, as well as the particular characteristics of each issuer. We prioritise research on sectors where we feel there is most ESG risk and/or limited third party ESG research.
Overall credit risk identification is enhanced through dynamic interaction between our RI and credit analysts, whilst mitigation of observable risks, through bond structure, pricing and portfolio construction, is the responsibility of our credit specialists.
We use ESG data to inform our opinions but are aware of the limitations of third party data. ESG risk is nuanced and its impact on credit risk will be materially impacted by the specific nature of the bonds we purchase (structure, credit enhancements etc.). We prefer to create bespoke ESG analysis that is debt specific to support our decisions. However, we recognise clients’ needs to provide accessible ESG data for reporting and regulatory purposes. Given our dissatisfaction with third party ESG data, which is often incorrect/incomplete and distant from the economic reality of how we lend, we are in the process of developing proprietary ESG ratings.
We buy external ESG data from MSCI, Trucost, SASB and RepRisk. We have built up a significant library of proprietary ESG data and insights on more debt-centric, but often high impact, issuers such as water utilities, social housing, infrastructure companies, and MBS. Our ESG ratings will incorporate these insights, co-created by the RI and credit teams, ensuring our data is tailored to fixed income.
Resources, Affiliations & Corporate Strategies
RLAM has an in-house team consisting of 11 Responsible Investment (RI) professionals that are a dedicated resource for implementing our stewardship and responsible investment activity by directly supporting front office teams to integrate material ESG research into investment processes.
The RI team is led by Head of Responsible Investment who reports to the Chief Investment Officer (CIO) and is a member of the Front Office leadership team. RLAM’s Investment Committee however has ultimate responsibility for setting RLAM’s risk appetite and reviewing our strategic risks. Our Chief Investment Officer is a regulated Senior Management Function (SMF) and is the Executive team member that is accountable for setting the investment strategy, and overseeing our Responsible Investment function, including our approach to stewardship and climate investment risk. The CIO, with support from the investment teams, updates the Investment Committee and monitors responsible investment in line with RLAM’s risk tolerance threshold. The CIO is also responsible for ensuring responsible investment, stewardship and climate change risk management is embedded across RLAM’s investment strategies. The CIO is a member of RLAM’s Executive Committee and chairs the Investment Committee.
UN PRI
RLAM has been a signatory to the United Nations Principles for Responsible Investment (UN PRI) since 2008.
As a result of our membership status, we commit to submitting and publishing our annual assessment response to demonstrate adherence to the principles. Our summary scorecard as at 2020 has been provided below. These scores are a testament to our continued efforts to become leading in responsible investment. We are engaging with the PRI to understand the current changes to its methodology and how we might need to adapt our practices to capture the required information according to these changes going forwards.
- Strategy & Governance - A+
- Listed Equity – Incorporation - A+
- Listed Equity - Active Ownership - A
- Fixed Income – SSA - A
- Fixed Income - Corporate Financial - A
- Fixed Income - Corporate Non-Financial - A+
- Fixed Income – Securitised – A
Stewardship Code
For a long time, we have been a tier one signatory of the 2016 UK Stewardship Code. That is why we wanted to be early adopters of the 2020 UK Stewardship Code, following its release in October 2019. After implementing the new reporting standards set by the FRC in our 2020 Stewardship report, a year earlier than required, we received highly positive feedback from the FRC and were featured as examples of best practice throughout the FRC’s Review of Early Reporting. We were recently recognised as official signatories to the Financial Reporting Council’s UK Stewardship Code 2020. This follows the submission of our Stewardship and Responsible investment 2021 report (covering our stewardship and responsible activities in 2020) earlier this year.
RLAM is also member of:
- Investment Association – Member of the IA Responsible Investment and Sustainability committee as well as the Climate Change and Stewardship working groups.
- UK Sustainable Investment and Finance Association (UKSIF), since 2016
- Climate Action 100+ – Co-leading engagement and dialogue with Glencore on climate risk. Member since 2019
- 30% Club Investor Group – We participate in regular investor meetings to discuss board and executive diversity and participate in collaborative engagement. Member since 2016
- Institutional Investor Group on Climate Change (IIGCC) – RLAM leads the sector-focused work on Utilities. We are also members of the Resolution and Paris Aligned Portfolios Advisory Groups. Member since 2019
- Workforce Disclosure Initiative (ShareAction) – We co-signed on the Workforce Disclosure Initiative, convened by ShareAction. Member since 2018
- Just transition – Joined in November 2020 and supported the launch of the Financing the Just Transition Alliance.
- Global Real Estate Sustainability Benchmark (GRESB) – We are a member of GRESB and our property team regularly engages with them on ESG performance in our property portfolio. We have been members since 2013.
- CFRF (FCA and PRA Climate Financial Risk Forum) – Disclosure working group member. Member since 2020
- TCFD – As part of our commitment with TCFD, which we formally became a signatory of in 2020, we are incorporating scenario analysis, for physical and transition risk into our analysis. We have several metrics and tools at our disposal to help us evaluate security and fund-level exposure to climate risks which we can use in quarterly ESG reviews, in-depth security analysis, or company engagement
RLAM signed the “Net Zero Asset Management initiative” in March 2021. This follows the Royal London Group commitment to the net zero investment framework earlier in the year. The Net Zero Asset Managers initiative launched in December 2020 and aims to galvanise the asset management industry to commit to a goal of net zero emissions.
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