Campe Goodman on how impact bond investors can shift the world into a better trajectory
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Focus is a publication that brings you face to face with a selection of the most in-demand asset managers in the UK and across the globe.
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Sustainable investing is growing fast and one of its newest tools – impact bonds – further increases the opportunities available to investors. By using impact bonds, debt investors can pursue returns while putting their money to work on solving the world’s biggest social and environmental challenges.
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Investment is subject to risk, including the possible loss of the money invested. Diversification does not ensure a profit or protect against a loss. Past performance is not a reliable indicator of future results. Currency movements can affect your investment returns. For more detailed information about the NN (L) Multi Asset Factor Opportunities fund, please refer to the prospectus and Key Investor Information Document available at www.nnip.com. This is a communication issued by NN Investment Partners B.V. (the “Company”), a Dutch limited liability company registered as an overseas company (registration number FC032623) and as a branch (registration number BR017698) in the register of companies for England and Wales, with its registered address at 25 Old Broad Street, London EC2N 1HQ. The Company is authorised by the Netherlands Authority for Financial Markets and subject to limited supervision by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. The research by AF Advisors has been prepared independently without influence of NN Investment Partners. NN Investment Partners cannot be held liable for the accuracy, correctness or completeness of the content thereof. The full report of AF Advisors ‘NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019’ can be downloaded from the website mafo.nnip.com.
Important information
IN THIS EDITION
CAPITAL: All investors should consider the risks that may impact their capital, before investing. The value of your investment may become worth more or less than at the time of the original investment. The Fund may experience high volatility from time to time. CONCENTRATION: Concentration of investments within securities, sectors or industries, or geographical regions may impact performance. CREDIT: The value of a bond may decline, or the issuer/guarantor may fail to meet payment obligations. Typically, lower-rated bonds carry a greater degree of credit risk than higher-rated bonds. CURRENCY: The value of the Fund may be affected by changes in currency exchange rates. Unhedged currency risk may subject the Fund to significant volatility. INTEREST RATES: The value of bonds tends to decline as interest rates rise. The change in value is greater for longer term than shorter term bonds. BELOW INVESTMENT-GRADE: Lower rated or unrated securities may have a significantly greater risk of default than investment grade securities, can be more volatile, less liquid, and involve higher transaction costs. EMERGING MARKETS: Emerging markets may be subject to custodial and political risks, and volatility. Investment in foreign currency entails exchange risks.
Risks
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In this Focus, Campe Goodman, portfolio manager at Wellington Management, discusses the key issues surrounding impact bonds including how capital can be steered towards the most beneficial projects. He also introduces the Wellington Global Impact Bond Fund, which has the goal of addressing some of the world’s most pressing challenges while seeking to provide strong financial returns.
What is the most urgent dilemma that investors face? Surely it is the need to pursue attractive rates of return while remaining conscious of risk. Portfolios may soon need to withstand end-of-cycle macroeconomic and geopolitical turbulence. In this guide, we look at one potential solution to these contradictory needs. NN Investment Partners Multi Asset Factor Opportunities (MAFO) fund is an absolute return factor fund that strives for capital growth and low correlation to traditional asset classes in investor portfolios. Willem van Dommelen, head of factor investing at NN IP, and Stan Verhoeven, lead portfolio manager in the factor investing team, explain their reasoning and tell the story of MAFO’s performance since 2016 in the face of Brexit worries, US-China trade wars and market volatility.
NN IP’s Willem van Dommelen and Stan Verhoeven on how investors can look beyond economic uncertainty to target long-term returns
What is the most urgent dilemma that investors face? Surely it is the need to pursue attractive rates of return while remaining conscious of risk. Portfolios may soon need to withstand end-of-cycle macroeconomic and geopolitical turbulence.
In this guide, we look at one potential solution to these contradictory needs. NN Investment Partners Multi Asset Factor Opportunities (MAFO) fund is an absolute return factor fund that strives for capital growth and low correlation to traditional asset classes in investor portfolios. Willem van Dommelen, head of factor investing at NN IP, and Stan Verhoeven, lead portfolio manager in the factor investing team, explain their reasoning and tell the story of MAFO’s performance since 2016 in the face of Brexit worries, US-China trade wars and market volatility.
Important Information
This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investing involves risk and an investment may lose value. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed are those of the author(s), are based on available information and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. Except where registered for public sale, Fund units are offered only to qualified or professional investors on a basis that it does not require the registration of the Fund for public sale. The Fund only accepts professional clients or investment through financial intermediaries. Please refer to the latest Key Investor Information Document (KIID), the Fund offering documents for further risk factors, pre-investment disclosures, and the latest annual report (and semi-annual report) before investing. KIIDs are available in the official languages of each country in which the Fund is registered for sale (please visit www.wellington.com/KIIDs). UCITS Funds are authorised and regulated as a UCITS scheme by the Commission de Surveillance du Secteur Financier-Wellington Management Funds (Luxembourg). This material is provided by Wellington Management International Limited (WMIL), a firm authorised and regulated by the Financial Conduct Authority (FCA) in the UK.
This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investing involves risk and an investment may lose value. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed are those of the author(s), are based on available information and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. Except where registered for public sale, Fund units are offered only to qualified or professional investors on a basis that it does not require the registration of the Fund for public sale. The Fund only accepts professional clients or investment through financial intermediaries. Please refer to the latest Key Investor Information Document (KIID), the Fund offering documents for further risk factors, pre-investment disclosures, and the latest annual report (and semi-annual report) before investing. KIIDs are available in the official languages of each country in which the Fund is registered for sale (please visit www.wellington.com/KIIDs). UCITS Funds are authorised and regulated as a UCITS scheme by the Commission de Surveillance du Secteur Financier-Wellington Management Funds (Luxembourg). This material is provided by Wellington Management International Limited (WMIL), a firm authorised and regulated by the Financial Conduct Authority (FCA) in the UK. CAPITAL: All investors should consider the risks that may impact their capital, before investing. The value of your investment may become worth more or less than at the time of the original investment. The Fund may experience high volatility from time to time. CONCENTRATION: Concentration of investments within securities, sectors or industries, or geographical regions may impact performance. CREDIT: The value of a bond may decline, or the issuer/guarantor may fail to meet payment obligations. Typically, lower-rated bonds carry a greater degree of credit risk than higher-rated bonds. CURRENCY: The value of the Fund may be affected by changes in currency exchange rates. Unhedged currency risk may subject the Fund to significant volatility. INTEREST RATES: The value of bonds tends to decline as interest rates rise. The change in value is greater for longer term than shorter term bonds. BELOW INVESTMENT-GRADE: Lower rated or unrated securities may have a significantly greater risk of default than investment grade securities, can be more volatile, less liquid, and involve higher transaction costs. EMERGING MARKETS: Emerging markets may be subject to custodial and political risks, and volatility. Investment in foreign currency entails exchange risks.
such as Brexit and the US-China trade war. But will fretting about headlines help them earn decent long-term returns? NN Investment Partners’ Stan Verhoeven thinks not. He argues investors distracted by short-term events should refocus on long-term return targets by building more diversified portfolios.
THE INTERVIEW
Can bond investors help change the world?
Name xxxxxx xxxx xxxxx xxxxxxx
Inflation outlook
Source: FactSet
Alasdair Ross, Lead Manager - Threadneedle (Lux) Global Corporate Bond Fund Alasdair is Head of Investment Grade Credit, EMEA. Alasdair is lead portfolio manager across various global, euro and sterling corporate credit portfolios including Threadneedle (Lux) Global Corporate Bond Fund, Threadneedle European Corporate Bond Fund, Threadneedle UK Corporate Bond Fund, and is also co-manager on the Threadneedle Credit Opportunities Fund. Between joining the company in 2003 and becoming a portfolio manager in 2007, he was a credit analyst responsible for covering the TMT, utility and energy sectors, as well as the sterling whole business securitisation sector. Prior to joining the company, Alasdair worked at BP plc in a rotation of commercial roles. Alasdair has a first-class honours degree in Politics, Philosophy and Economics from the University of Oxford. He also holds the Chartered Financial Analyst designation.
In March a portion of the yield curve inverted for the first time since July 2007 – and some investors are twitchy. Led by US treasuries, short-term government debt around the world has been offering higher returns than long-term bonds, a trend widely seen as the most reliable sign of oncoming recession. Consensus is hard to find, however. A particularly decisive flattening in the US market in March led Morgan Stanley to issue a warning to its clients. In the opposing camp, JPMorgan Chase’s Jamie Dimon struck a more upbeat note. He believes the yield curve’s value as an indicator has been muddied by the actions of central banks and regulators.
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(4) It can be difficult to draw a firm conclusion about the green premium across markets and issuers. For some discussion, see Maria Jua Bachelet, Leonardo Becchetti and Stefano Manfredonia, ‘The Green Bonds Premium Puzzle’, February 2019; Suk Hyun, Donghyun Park and Shu Tian, ‘The Price of Greenness’, August 2018; The Climate Bonds Initiative, ‘Green Bond Pricing in the Primary Market’, May 2018.
Building common standards and ways to report KPIs is Challenge Number 1
Stan Verhoeven From 2007 to 2011, Stan worked at Kempen & Co as a quantitative analyst and (exotic) derivatives trader. He joined RBS in London in 2011 and moved to PGGM in 2012, where he was responsible for research into alternative risk premia. In 2015, he joined the Factor Investing team at NN Investment Partners, where he develops and manages a broad range of rule-based strategies, in addition to being Lead Portfolio Manager of MAFO. He is a CFA charterholder and holds an MSc in Business Administration from Radboud University, Nijmegen.
Diversification in any portfolio is most critical in uncertain times. But investors need to focus on the effect any additional investment has on their existing portfolio, rather than simply making sure that any new fund they add is diversified in itself. Traditional investor portfolios are often already biased towards long equity and fixed income. Multi-asset funds shouldn’t add to those concentrations. Instead, Verhoeven argues that multi-asset funds should be portfolio “building blocks” that target attractive absolute returns, on the one hand, and diversification in relation to traditional investments, on the other. “So we make sure our Multi Asset Factor Opportunities (MAFO) fund has no long bias towards equities”, he says, or indeed towards fixed income or any other asset class.
Building blocks
MAFO trades a breadth of assets including commodities – an asset class outside the stamping ground of most traditional multi-asset funds. The nice thing about commodities, says Verhoeven, is that while equity markets are dominated by speculators, commodities markets attract additional participants such as producers managing risk and end consumers. In effect, MAFO, through investing, provides services such as market liquidity, to these participants and receives a return compensation for facilitating this. MAFO doubles up on diversification by applying multiple factor strategies across the various asset markets based on value, momentum, carry, flow and volatility. Factor strategies often have low correlations to traditional investments and low correlations to each other. “If you have one strategy with a Sharpe of 0.25, that may not sound amazing, but if you can create 16 of those with zero pairwise correlations your portfolio would have a Sharpe of 1,” says Verhoeven. Of course, MAFO can feel short-term pain from market ups and downs, with Verhoeven citing energy market volatility in November 2018 as a recent example. But over the longer term, he says, its returns should not be dominated by specific market or geopolitical events. Other segments of the alternatives industry such as hedge funds do access the same markets as MAFO but lack its transparency. “Our strategies are the opposite of a black box: we show a lot of detail about what we are doing and why, which a typical hedge fund will never do”, Verhoeven says. The goal is that investors can place MAFO in their portfolios and understand what might happen.
Doubling up diversification
To explain his investment process, Goodman describes what happened after he first set out the fund’s criteria to Wellington’s broader credit teams. “I soon got an email from an analyst who had identified a really interesting high-yield issuer: a company in Brazil that provided clean water and better sanitation,” Goodman explains.
Identifying impact
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Impact bond investing is the segment of sustainable investing that channels debt market capital towards solving these challenges. The size of global debt markets means that impact bonds could be a huge lever for change, says Campe Goodman, who manages Wellington’s first impact bond fund.
Boston-based Goodman says that impact investing should address three categories of urgent global challenge:
• Life essentials, e.g., access to basic needs such as clean water and housing • Human empowerment, e.g., education, financial inclusion and bridging the ‘digital divide’ • Protection and improvement of the environment, e.g., through renewables and recycling
Planetary priorities
managed drinking water. (1)
he world faces diverse challenges from climate change and rising sea levels to the lack of affordable housing in developed economies. Some challenges threaten the planet, others threaten people – three out of ten people in the world lack safely
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Mission to measure
Goodman thinks investors need KPI information to steer capital in the most beneficial direction. “If I were to put $100m in a particular investment, what impact would I get and how would I compare that to other investments?” he asks.
At the moment, issuer reporting varies in form and quality. “Building common standards and ways to report KPIs is Challenge Number 1 and could help the market grow,” Goodman says.
KPIs will also reassure investors. “The fear of greenwashing is a bigger challenge to impact investing than the limited scale of the greenwashing itself,” he says. Most greenwashing issues can be solved by thoughtful managers who look hard at what they are buying, including using KPIs. “So we will work with issuers to create KPIs,” he says, “but if no credible KPIs result, our fund will disinvest.”
Other segments of the alternatives industry such as hedge funds do access the same markets as MAFO but lack its transparency. “Our strategies are the opposite of a black box: we show a lot of detail about what we are doing and why, which a typical hedge fund will never do”, Verhoeven says. The goal is that investors can place MAFO in their portfolios and understand what might happen.
The team checked the firm against the fund’s key criteria – impact theme, additionality and KPI measurability – and added the firm to the fund’s universe of possible investments. That’s the first hurdle for an issuer.
Then when Goodman began selecting high-yield issuers for his portfolio, he spotted the water firm’s “great risk/reward and investment characteristics”. So he double checked with the credit analyst and ran the idea past one of Wellington’s experienced emerging markets portfolio managers, before sizing and sourcing the investment.
For Verhoeven, the real success is that MAFO achieved this while demonstrating low correlation with equity markets.** Uncertain times, he argues, are precisely when successful investors should turn off their newsfeed and focus on engineering portfolios to make long-term returns.
Measurable Impact
market outlook
But how can funds like Goodman’s prioritise and measure the impact of investments? And can bond investors help solve social and environmental problems without sacrificing returns?
Goodman, who has contributed to community services around Boston for more than 20 years, is particularly passionate about human empowerment. (2) But he argues that impact investing also demands rigour.
To be selected for Wellington’s new fund, an investment must address one of Goodman’s three impact categories and be ‘additional’ in that the impact can’t be easily achieved in other ways.
Critically, the bond’s impact on the world must be measurable through a quantitative key performance indicator (KPI), such as the amount of CO2 or methane emissions avoided, the percentage of charity care provided by hospitals, or the units of additional affordable housing constructed.
Everyone supports the drive for clean water, but some other impact areas are more controversial. “We’d like to help fund the transition of ‘dirty’ industries like metals and mining towards more environmentally-friendly practices because we think that could be incredibly impactful,” says Goodman. But his experience with energy utilities highlights a problem.
“A lot of utilities are issuing green bonds for their wind power,” he says, “but only some are actively shutting down thermal activities and moving towards wind and solar.” Impact investors must be selective. “We want to buy the bonds of firms making a real transition,” he says.
In other industries, he says, it can be even more of a challenge to try to make sure “we aren’t providing any capital to negative impact activities at all.” The answer may be future innovation in the form of ‘transition bonds’ structured to meet a high bar of transparency and sustainability goals. (3)
Creative controversy
Must fixed-income investors necessarily sacrifice returns in order to support impact bonds? No, says Goodman, citing two arguments:
He fears negative thinking might slow the flow of capital to critical projects. Goodman hopes to build a track record of strong returns and measured impact that changes the sceptics’ minds.
Sidestepping sacrifice
• All investors constrain themselves in some way. “We’re focusing on issuers providing services and goods such as alternative energy that will be in demand in the future,” he says. • Green bonds, and other bonds in Wellington’s impact universe, do not seem to trade at a substantial premium, in Goodman’s experience, though empirical evidence is mixed. (4)
However, Goodman is worried about one thing: “I’m amazed at the number of sceptics who still think impact funds will fail to make an impact and fail to make returns,” he says.
Building belief
(2) See Goodman’s biography in Fund Q&A for details of his recent community service work.
(1) See UN World Water Development Report 2019, Leaving No One Behind, p.18: http://bit.ly/2l7c4En
We want to buy the bonds of firms making a real transition
Campe Goodman, portfolio manager, Wellington Management
(3) For example, see discussion in Tom Freke, How ‘Transition Bonds’ Can Help Polluters Turn Green, Bloomberg Businessweek, 14 July 2019: https://bloom.bg/2lFwh4k
uncertainty
quantitative easing, a possible bear market in equities, and geopolitical events such as Brexit and the US-China trade war. But will fretting about headlines help them earn decent long-term returns?
or the next couple of years, uncertainty is king. Investors are worrying about the end of the economic cycle and
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Campe Goodman, portfolio manager
Wellington Global Impact Bond Fund
Wellington Management
fund launch
Risk target/budget
Base currency
23 March 2016
10% long-term volatility
USD
Source: Columbia Threadneedle Investments at 31 March 2019.
Ahead of the curve: reading the runes on risk
• Value • Momentum • Carry • Flow • Volatility
• Equity • Fixed income • Currencies • Commodities
return objective (1 month US Libor)
+ 6%
KEY FACTS
“All peers realised cumulative three-year returns between 0% and 10%, whereas the NN IP strategy is the only factor-based strategy that yielded substantial returns even given its relatively high volatility.” AF Advisors (2)
NN IP Multi Asset Factor Opportunities
“In summary, NN IP’s relatively lean and mean approach towards alternative risk premia investing enables it to charge lower fees versus its peers, but at the same time it is achieving attractive returns against an acceptable risk. As such, NN IP may be considered an attractive alternative within this segment.” AF Advisors
Fund size (mid-basis)
Value, momentum, Carry, flow, & volatility
5 factors
Investment philosophy
NN (L) Multi Asset Factor Opportunities
Gross returns over relevant risk free rate of NN (L) Multi Asset Factor Opportunities versus direct peers (1)
Factor performance (1)
Source: (1) Morningstar Direct (3 year, May 2019) via AF Advisors. (2) AF Advisors, NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019
NN (L) Multi Asset Factor Opportunities: Key statistics (2)
Source: (1) NN IP Factor Investing team. As at 30 April 2019. (2) NN IP, Bloomberg. Data from April 30, 2016 – April 30, 2019 and quoted in USD. Equities is MSCI World Net Total Return (NDDUWI) and Fixed Income is the Bloomberg Barclays Global Agg. Government Total Return Index (LGAGTRUU). MAFO refers to NN (L) Multi Asset Factor Opportunities I-share USD (gross of 0.81 bps annualized ongoing charges). The indices mentioned here are presented for the purpose of comparing with equities and fixed income, and should not be considered benchmarks.
MARKET OUTLOOK
NN (L) Multi Asset Factor Opportunities: Factor performance
Gross returns over relevant risk free rate of NN (L) Multi Asset Factor Opportunities versus direct peers
NN (L) Multi Asset Factor Opportunities: Key statistics
Source: NN IP Factor Investing team. As at 30 April 2019.
Source: Wellington Management as at 30.06.2019. For illustrative purposes only.
Correlations of NN (L) Multi Asset Factor Opportunities and direct peers vs equity and fixed income benchmarks
Source: AF Advisors calculations based on Morningstar Direct data (3 year, May 2019).
Source: AF Advisors, NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019.
Source: AF Advisors, NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019
Source: Wellington Management as at 30.06.2019.
“All peers realised cumulative three-year returns between 0% and 10%, whereas the NN IP strategy is the only factor-based strategy that yielded substantial returns even given its relatively high volatility.” AF Advisors
FACTORS
ASSET CLASSES
5
4
(Gross)
FUND TYPE
11 (currently invested in 10)
IMPACT THEMES
Global Impact Bond
30 April 2019
INCEPTION DATE
Strategy launched in 2017
Bloomberg Barclays Global Aggregate, hedged to US Dollar Index
REFERENCE BENCHMARK
Government, agency, supranational, municipal, corporate and securitised
SECTORS / ISSUERS
Key facts
Impact themes invested in (market value %)
Our investment themes
Wellington has identified 11 areas of pressing social and environmental need, grouped under three categories, where we believe a real impact can be made. These themes are broadly aligned with the United Nations’ Sustainable Development Goals (SDGs).
Digital divide
Education and job training
Financial inclusion
Safety and security
HUMAN EMPOWERMENT
Human empowerment
Environment
Life essentials
Affordable housing
Clean water and sanitation
Health
Sustainable agriculture and nutrition
ENVIRONMENT
Alternative energy
Resource efficiency
Resource stewardship
LIFE ESSENTIALS
Data shown as of 2018. This work is illustrative of research carried out by Wellington Management. Developed on an issue by issue basis, leveraging, company/issue reports, publications and data-bases. The examples shown are presented for illustrative purposes only and are not to be viewed as representative of actual holdings. It should not be assumed that any client is invested in the (or similar) example, nor should it be assumed that an investment in the example has been or will be profitable. Actual holdings will vary for each client and there is no guarantee that a particular client’s account will hold the examples presented. Source: company/issue reports
Measuring impact in fixed income – illustrative examples
Campe works with a seven-strong team based in Boston and London. The team includes specialists in fixed income and ESG analysis, taking full advantage of Wellington’s wider resources, including expertise in investment grade credit, emerging markets debt and local agency debt.
Meet the Wellington Global Impact Bond Fund team
BOSTON
LONDON
Marc Piccuirro, CFA
Jennifer Rynne, CFA ESG analyst
Campe Goodman, CFA portfolio manager
Virginie Pelle
fixed income portfolio manager
fixed income credit analyst
investment specialist
Jake Otto, CFA
Meredith Joly
IMPACT
0.022% of annual global CO2 emissions avoided.
OUTCOME
7,434,091 metric tons of CO2 equivalent avoided.
OUTPUT
13,957,000 MWh of clean energy produced.
ACTIVITY
Allocate 81% of proceeds to wind and solar energy production projects and 19% to projects that improve efficiency in transportation.
ISSUER
European green bond
0.0031% of cost-burdened households provided with affordable housing at the national level.
Affordable housing stock increased by 0.45% on average by state.
644 affordable rental units constructed.
Mortgage loan issued to provide financing for construction of multi-family rental property.
Low-income multi-family rental property
CLICK TO VIEW THEMES
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Looking beyond
Name xxxxxx xx xxxxxxx
The factors we employ have three distinct drivers of return
Campe Goodman, CFA Senior Managing Director, Partner and Fixed Income Portfolio Manager Campe is a portfolio manager on Wellington’s Impact Team and Broad Markets Team. He has been managing multi-sector fixed income portfolios for nearly two decades. He is the lead manager on Impact Bond and Multi-Sector Credit portfolios, and he also leads a specialist team responsible for the development of sector rotation strategies. Outside the firm, Campe is a board member and former board chair of a Boston-based non-profit organisation that helps individuals, including many immigrants and refugees, to find employment and develop their careers. Prior to joining Wellington Management in 2000, Campe spent four years at the Massachusetts Institute of Technology studying macroeconomics and finance in a doctoral programme in economics. He received his AB in mathematics, magna cum laude, from Harvard College (1995). In addition, Campe holds the Chartered Financial Analyst designation.
What is the purpose of the Wellington Global Impact Bond Fund?
If people see strong returns, they’ll gain confidence they can meet both investment and impact objectives
In short, two objectives: strong financial returns and addressing some of the world’s social and environmental challenges through impact investments.
For us, those challenges fall into 11 themes, divided into three major groups. First, life essentials, which covers things like clean water and sanitation, health, affordable housing; second, human empowerment, which includes improving education, financial inclusion and bridging the digital divide; third, protection and improvement of the environment, which includes alternative energy, recycling and renewable resources, broadly speaking.
We developed these themes prior to the development of the UN SDGs (1) and have stuck with them because we think our themes capture what is investible. They’ve resonated with clients and we wanted to keep some consistency in what we’ve done. We’ve also mapped every issuer that we have in the portfolio to one or more of the specific sub-goals under one of the 17 UN SDGs – so there’s no problem showing clients how the portfolio aligns with the UN SDGs.
How do those themes relate to the well-known United Nations Sustainable Development Goals?
It’s a two-step process. We identify the issuers and create our universe of impact issuers – setting a high bar. Then from that universe, we construct the portfolio that we think is going to have the risk/return characteristics we are looking for.
How do you select investments for the fund?
But we lost out in November on the back of a spike in natural gas prices early in the month and later a huge drop in energy prices. So in Q4 overall we went down, like a lot of funds, but actually not in the same months as equity funds. That’s the big message: we’ve outperformed our target over the full three years while demonstrating low correlation with equities.
Seven of us work on this approach, including two lead portfolio managers. I’m responsible for the overall direction of the portfolio and for every buy and sell decision. But we take full advantage of Wellington’s resources, including talking to almost all of the credit analysts and a number of specialist portfolio managers. So when we want to know what impact bonds are available to us in emerging markets, for example, we speak with our entire team of emerging market specialists.
How do you find the best impact investments?
Our focus on simplicity enables us to understand the sources of return (factors) that we harvest and what risks they entail. Our approach is built on a robust research process whereby we regularly re-evaluate our strategies to ensure we are not dogmatic.
The individual factors we apply have proven their worth in practice over the longer term and are here to stay. As mentioned earlier, they pick up different sources of returns and hence are uncorrelated to each other (and to traditional investments). So what drives the ability to target absolute return is the positive expected return of factors over the long term and their low pair-wise correlations.
So what drives that ability to target an absolute return, beyond diversification benefits?
In case factor A does not perform in period X then, since factors are relatively uncorrelated and have long-term positive expected returns, it is likely that factors B and C will perform - so on a net basis there is an absolute return.
MAFO is built on active research to find, assess and review the factors used in the model. We implement the model on a daily basis to optimise its performance. The real point is that factor investing must be systematic: the strategy should deliver the exact same thing in the future as in the past, given the same market environment. Markets never stay the same, of course, but the contrast with traditional discretionary managers is clear: they can change their opinion and react quite differently to similar markets.
So is factor investing passive or active?
There are three key steps to imposing discipline. Every factor strategy we include in our portfolio must have a clear and strong economic rationale and academic underpinning; must have proven itself over the long run, in and out of sample and across asset classes; and must offer attractive returns taking into account implementation costs.
Is a disciplined approach easy to build given that the growing number of factor approaches include some that seem spurious or that side-step real-world issues, e.g., implementation costs?
You do have to build a rigorous research process – and you do have to stick to it!
OUR RESEARCH PROCESS
Idea generation
Data collection
Testing base model
In-depth research
Implementation
Periodic review
Fully systematic process
Investment process
Efficient implementation and execution
Detailed risk monitoring and reporting
Dedicated factor investing team MAFO is managed by NN Investment Partners’ factor investing team. The seven-strong team of portfolio managers combines quantitative research and portfolio management, working closely with NN IP’s trading team and the centralised innovation and data team. They are led by Willem van Dommelen and Stan Verhoeven.
Click for van Dommelen’s view
One of the big problems in the UK and other developed countries is insufficient affordable housing. UK housing associations are a great way to address that so we’ve been buying bonds issued by some of them. Likewise, we invested in a quasi-governmental transportation authority in the UK that issued a green bond to make improvements to train capacity in a major urban centre, and to expand hybrid buses and create more cycle lanes.
Can you give examples of your impact investing in the UK?
One of the most straightforward is metric tons of CO2 and methane emissions that have been avoided. That’s generally a good KPI for clean energy. Other KPIs include units of affordable housing created or, for hospitals, dollars of charity care provided, or the number of people provided with clean water.
What key performance indicators (KPIs) do you use to measure impact?
I’d say there isn’t any skew in the universe of impact bonds that makes it either riskier or less risky than the whole universe of bonds. There’s a range of high-quality impact bonds available – including quality sovereigns and multi-nationals – that provide really great protection in a negative cycle environment. Then there are more risky investments that are great to have in an early or mid-cycle environment. So we feel we’re able to position the portfolio right now as defensively or as aggressively as we want to.
Is there any reason to think impact investing is risky this late in the economic cycle?
First, we’re seeing more issuers, and we’re also seeing more issuers figuring out how to package some of their activities as impact investments. So the supply of investment opportunities is growing, though I’d love to see it grow even faster.
How will impact bond investing evolve over the next 3-5 years?
Second, demand is growing. I’ve been doing fixed income investing for 20 years and, even five years ago, nobody was talking about impact bonds. Absolutely nobody. The growth of interest is amazing.
But because global needs are so great, the big challenge is to get even more investors coming into the space. Hopefully, if people see strong returns, they’ll gain confidence that they can meet both their investment and their impact objectives.
Third, standards and KPI measurement will evolve over time. We’ve got lots of good ideas but other people will have good ideas as well. We want to be sure our reporting is best in class. One thing that won’t change is our twin goal: generating strong investment returns and having a positive social and environmental impact.
Aligned with select UN Sustainable Development Goals
Wellington Management supports the UN SDGs. Our Fund is currently aligned with 13 of the 17 Sustainable Development Goals set by the UN
(1) See United Nations, 17 Goals to Transform Our World: https://www.un.org/sustainabledevelopment
