Inside EQ’s impact portfolios: Buy Baillie Gifford & Ninety One

EQ Investors has become a thought leader in impact investing. We ask head of investment Sophie Kennedy about the firm’s crucial calls in 2020.

Ask anyone what has defined 2020 for investment and you are likely to get one answer: ESG.

Of the firms in New Model Adviser’s annual Top 100, 98% offered ESG investing to some degree, with many launching new propositions in 2020. Around 14% of recommendations made over the past year were into funds with an ESG screen. Across all the firms, £1.9bn is now invested in ESG propositions.

All this seemed a long way off when NMA put together a special edition on ESG investing in February. For that special project we spoke to London-based EQ Investors about its impact portfolios. With the end of the year approaching, we caught up with EQ’s head of investment Sophie Kennedy (pictured) to find out about the important funds in the portfolio over 2020.

You can watch a video of Kennedy’s thoughts here!

Ask anyone what has defined 2020 for investment and you are likely to get one answer: ESG.

Of the firms in New Model Adviser’s annual Top 100, 98% offered ESG investing to some degree, with many launching new propositions in 2020. Around 14% of recommendations made over the past year were into funds with an ESG screen. Across all the firms, £1.9bn is now invested in ESG propositions.

All this seemed a long way off when NMA put together a special edition on ESG investing in February. For that special project we spoke to London-based EQ Investors about its impact portfolios. With the end of the year approaching, we caught up with EQ’s head of investment Sophie Kennedy (pictured) to find out about the important funds in the portfolio over 2020.

You can watch a video of Kennedy’s thoughts here!

The rising star: Ninety One UK Sustainable Equity

EQ Investors made a strategic decision to reduce its exposure to UK equities towards the end of last year.

‘That decision was mainly based on the sector exposure,’ says Kennedy.

‘Investing in UK equities gives you a underweight to tech and a overweight to some large energy companies, where stranded assets might be an issue.’

Stranded assets have become an important theme for investors looking at sustainability. The term was coined by think-tank Carbon Tracker and refers to assets that will, in the not-too-distant future, no longer deliver an economic return as the world moves towards carbon neutral targets. Fossil fuels are one.

According to EQ’s Positive Impact Report for 2020, the FTSE 100 has nearly 10,000 tonnes of disclosed CO²-polluting reserves from coal, oil and gas companies. The MSCI World Index has just under 4,000 tonnes. EQ’s portfolios have none.

Some of these fears played out during this year, when a lower demand for fossil fuels during the lockdowns around the world, coupled with geopolitical tensions between oil-producing nations, sent the price of oil falling.

This in turn led oil companies to slash their dividends and put investors off the traditionally popular companies. By the end of November, BP’s share price was down 48.5% compared with the start of the year, while Royal Dutch Shell’s was down 43.7%.

‘From both a traditional financial perspective and an impact perspective, there are better opportunities elsewhere,’ says Kennedy.

However, there are still some ‘fantastic funds’ in UK equities for impact investors, says Kennedy. She highlights the £43.4m Ninety One UK Sustainable Equity fund, managed by Citywire AA-rated Matt Evans.

Although the fund is small and has only been running for two years, it has impressed EQ’s team. It returned 4.8% in the 12 months from December 2019 to November 2020, outperforming the Morningstar UK benchmark and the popular Royal London Sustainable Leaders Trust (see chart above).

‘Evans is well aware that the UK market has its constraints in impact investing,’ says Kennedy.

‘What we are looking for and working with him on is the transition. It is about pushing these companies to be the best in class and improve, which is a great way to make an impact.’

In its annual impact report for 2019, the fund gave an example of engaging with energy company Ceres Power. Evans, who also holds Ceres in the £249.8m Ninety One UK Small-Cap fund he manages, first held the company in July 2018.

The following year the fund raised concerns about Ceres’ lack of an ESG policy, prompting it to set clear targets against the United Nations’ Sustainable Development Goals (SDG). According to the report, Evans planned to meet the newly formed Ceres ESG committee in 2020.

Sticking with the company has paid off for the fund. It was the portfolio’s top contributor in the three months between September and November, returning 53.7% and contributing 1.2% to the fund’s performance over that period, according to Morningstar.

Alongside the Ninety One fund, EQ Investors also uses the £2.3bn Royal London Sustainable Leaders Trust, which is managed by Citywire AAA-rated Michael Fox, for large-cap exposure in the UK.

The big name: Baillie Gifford Positive Change

Outside of the UK, EQ Investors has turned to a fund that has proven a very popular pick with advisers this year. Baillie Gifford’s Positive Change fund was running £220m at the start of January. By the beginning of October, the fund had ballooned to £1.3bn in size.

Growth has been partly driven by institutional wins, such as a deal with Swedish insurance group Länsförsäkringar in November to run sustainability-themed funds on its platform. It has also been driven by advisers and managed portfolio services (MPS) choosing it after it reached its three-year anniversary in January.

‘We looked at it in 2017, and we took a further look in 2018,’ says Kennedy.

‘At that time, given our stringent investment approach, we did not feel the fund had the track record and there was not sufficient evidence that the managers could consistently generate alpha. Front and centre for us is maximising financial returns, and we could not quantify that.’

After three years of running the fund, its management team – Kate Fox and Lee Qian (both Citywire AAA-rated), Michelle O’Keeffe and Ed Whitten – have shown they can generate positive returns over an extended period. In the three years to the end of November, the fund returned 137.8%, a result driven largely by the performance of top holding Tesla.

It was not just performance concerns that stopped EQ Investors from investing in Baillie Gifford Positive Change back in 2018. The fund also held Chinese technology company Tencent at the time.

‘The holding wasn’t in line with our impact approach,’ says Kennedy.

Tencent’s main product is WeChat, one of the biggest social media platforms in China. It also has access to 50% of China’s gaming market, something critics thought was harmful. Indeed, it was ‘a source of concern’ for the Positive Change management team. This year, the situation became untenable.

‘Previously we felt the social utility gained by the 1.2 billion users of WeChat, and the entertainment value that most gaming users experience, outweighed the few for whom gaming becomes a problem,’ the fund’s annual impact report stated.

‘However, our conviction in this argument waned throughout 2019 and we became increasingly uncomfortable with how Tencent’s products were being used for state surveillance and censorship. Having discussed these issues at length, we decided to sell our holding in Tencent in Q1 2020 due to the potential negative impacts arising from the company’s products.’

Kennedy says the fund’s decision to divest from Tencent alongside its strong performance tipped the balance for EQ. It decided to invest in the fund as a result.

‘It gives us great exposure to European companies and to healthcare. If we see parts of those markets doing well, it will outperform. It also benefits when we see significant government infrastructure spend. During the global pandemic we have seen governments push fiscal spend globally, which has benefited the fund.’

The underrated fund: Wellington Global Impact Bond

Kennedy says the £102.5m Wellington Global Impact Bond fund, managed by Campe Goodman (pictured), offers diversity for investors but is one of the most underrated funds in the company’s portfolio [watch video of her comments on the fund here]. 

‘Wellington Management is relatively unknown in Europe but is a huge player in the US, with more than $1tn (£743.7bn) of assets,’ says Kennedy.

‘It was one of the first asset managers to launch a Global Equity Impact Fund [managed by Citywire + rated Tara Connolly Stilwell], it has a really stringent process and best-in-class impact reporting.

‘Last year Wellington leveraged its experience in this space and launched a bond strategy, which is very ambitious in terms of impact analysis and reporting within fixed income.’

Fixed income is often a tricky area for impact investors to allocate to. Long project horizons make it hard to see and measure an impact, while varying standards across the world make it difficult to see where proceeds from bond raises end up. The issue of cash ring-fencing also plays a part. Kennedy says Goodman’s fund tackles these problems.

‘For a UK investor, it provides access to global bonds where proceeds are directly financing, green or social projects.’

An example listed in the fund’s annual impact report is German development bank KfW, which issues funding to projects addressing environmental, educational or social issues.

It has, for example, funded the construction or refurbishment of 370,000 energy-efficient houses. Wellington notes this contributes towards the UN’s SDG on climate action. Unlike some impact bonds, it is made clear where this money ends up and how it has a positive impact. Investors have also reaped performance benefits.

‘It comes back to diversification and portfolio construction. The fund is relatively defensively positioned, so it was one of the best performers in Q1 2020, when we saw the initial reaction of the markets to the pandemic,’ says Kennedy.

Over the first quarter of 2020, the Wellington Global Impact Bond fund returned 6.5%. Over the same period, even the top-performing Baillie Gifford Positive Change fund posted returns of -4.7%.

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