The objective of the fund is long-term capital growth. It invests in a diversified portfolio of equities and equity type instruments which are listed in the UK and carry out a substantial part of their operations here.
The fund adheres to a strict ethical process which applies both negative and positive screens. The methodology is agreed with the ASI Ethical Funds Advisory Group and rules out companies that have a detrimental effect on society or the environment. Typical ethical exclusions are: animal testing, genetic engineering, alcohol, gambling, tobacco and weapons.
Positive screening identifies areas which make a positive contribution to the environment and/or society and have the potential for high growth. This may include: environmental technology and pollution control businesses, as well as those with high standards of behaviour and ethics as well as willingness to engage with the community.
This is currently very much a multi-cap fund, with around 75 holdings, of which a quarter are in the FTSE 100, half in the FTSE Mid 250 and the remainder in smaller companies or AIM shares.
Lesley Duncan has managed this fund since 2004. She is head of the ethical franchise and also deputy head of UK equities. The team has been expanded following the merger of Standard Life with Aberdeen Asset Management.
As well as conducting its own ESG research, the team utilises the resource of the entire UK equities team; this consists of fund managers and analysts (16 large cap and 7 small cap) who each have sector responsibilities. Around 1,000 company meetings are conducted every year.
Investment philosophy & process
The core philosophy is that carefully selected holdings that meet the defined criteria are well placed to outperform the broader market. Duncan believes that companies which behave in a responsible manner are more likely to comply with legislation and corporate governance guidelines. This is important as consumers are displaying more concern about the impact of products and services they use.
The first step is the screening process. This is conducted by a team which engages directly with companies and is proactive in voting on ethical issues. Advice is also taken from an independent investment advisory committee.
Assessing and judging externalities and the risk they might pose to an investment is an essential addition to fundamental company analysis. Social and environmental costs, and their risks, may not be shown in the accounts but are investigated in order to understand more fully the potential threats to shareholders’ returns.
The team employs a ‘focus on change’ philosophy to identify companies where positive change is not priced in, with a ‘no compromise’ stance taken. This means if a company fails on one of their screens it is excluded. Increasingly, consideration is given to companies that are acting in a positive manner, as they believe this is likely to appeal to ethical investors.
The process excludes individual companies or entire sectors which are deemed unacceptable on ethical grounds, and the resultant universe is focused on growth stocks. As a result, the portfolio has a bias towards smaller, innovative companies and away from mature sectors such as tobacco, defence, oil & gas, mining and pharmaceuticals.
The specialist analysts produced a list of approved companies. Currently, around 78% of the 332 companies in the FT All Share index are deemed acceptable on ethical/ESG/impact criteria. Duncan then selects investments from this shortened list. The UK equities team also constructs a ‘winners list’ and a number of stocks have been drawn from this.
The team seeks ambitious companies that understand the importance of looking after their employees, customers and shareholders as well as the environment. An annual survey is sent to holders of the fund which asks their views on relevant issues. This resulted in the exclusion of the entire oil and gas sector from 2018 onwards.
A holding is typically started with around a 0.8% position, regardless of company size, and those that do well are allowed to appreciate to around 4%, at which point Duncan starts to take profits. The current breakdown is approximately: 24% in FTSE 100, 49% Mid Cap, 8% Small Cap and 18% other (mostly AIM).
A key sector overweight position is house builders and associated building materials companies such as Howden and Polypipe. Despite the ‘Help to Buy’ scheme being phased out they believe the government will introduce further incentives and the underlying under-supply situation will support revenue growth for some time.
The biggest holding is fast fashion retailer boohoo.com. This came under scrutiny last year over reports of poor employee conditions at some of their UK suppliers in Leicester. The team engaged with the company and is satisfied that sufficient action has been taken to address the issues by reducing the number of suppliers and making spot checks. Products are 50% UK sourced (much higher than Next or ASOS) where standards are more stringent, and they are also have a programme to improve sustainability of fabrics.
Petrol station manager DCC was sold, as its operations were felt to be too ‘close’ to the fossil fuel debate, while Ted Baker was removed as soon as, what was considered poor management behaviour, came to light. The new management are being kept under review. Barclays was excluded after a ‘whistle blowing’ incident but after an investigation Duncan felt sufficient changes have been made and the bank has been reinstated.
Performance & Costs
The fund has performed well over the long term. Since the start of Lesley Duncan’s tenure (01/06/2004) it has returned an annualised 8.96% p.a. compared with 8.02% p.a. for the FTSE All Share (source FE Analytics).
Over 5 years to 31/07/2019 total returns are 51.1% vs 38.9% for the FTSE All Share, while over 3 years the fund has returned 36.5% vs 27.0% for the index (FE analytics).
We believe an ongoing charges figure of 0.9% plus transaction fees of 0.11% is reasonable considering the extra work involved in implementing this strategy.
The manager believes that the available universe for this fund is actually growing because companies are generally improving their ethical standards, with a growing choice of companies engaged in positive and sustainable activities. Many are driven by demand that should be fairly resilient to a general economic slowdown.
Furthermore, there is mounting evidence that investing with a conscience does not mean sacrificing returns and indeed may actually enhance them.
ASI have one of biggest ethical teams and this fund has a solid track record under Lesley Duncan. We like the clear process with screening kept separate from the investment desk. Increasing interest in the field means companies with strong credentials are likely to command higher valuations and generate long-term value.
A unique selling point for this fund is its engagement with investors and willingness to listen to their views. All investor correspondence is monitored and carefully considered. We think this level of interaction means the fund could satisfy investors with fairly strict ethical values.
However, we note that the significant divergence from FTSE All Share structure may mean that short-term performance could demonstrate above average volatility.
Important information: Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Nothing in this article is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment.
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