SRI/ESG Investments-Calvert Funds

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Back in January we initiated a discussion on the Socially Responsible Investing and its close cousin Environmental, Social and Governance investing. We continue to believe in this trend individually and at an institutional level. It used to be thought that returns have to largely be sacrificed in order to adhere to SRI criteria.

According to the US SIF Foundation’s 2012 Report on Sustainable and Responsible Investing Trends in the United States, as of year-end 2011, more than one out of every nine dollars under professional management in the United States—$3.74 trillion or more—was invested according to SRI strategies. The next Trends report on SRI assets will be published in the fourth quarter of 2014.

We anticipate that there will be a higher number and that the growth rate will be just as impressive. Socially responsible investing doesn’t have to sacrifice profits for ethos.

Aaron Levitt an Investor Place Contributor wrote an article on March 21st of this year addressing some issues with regard to performance and SRI. According to Goldman Sachs (GS), firms that are considered to be leaders in socially responsible investing have also been leaders in terms of stock performance as well — averaging an extra 25% over the longer term. This echoes similar research conducted by Allianz. Between 2006 and 2010, the German insurance group found that investors could have added an additional 1.6% a year to their investment returns by allocating to portfolios that invest in companies with above average ESG ratings.

Calvert Investments located in Bethesda, MD is a firm that dedicates its asset management process in large part to SRI/ESG investing. Today we will provide a basic outline with regard to three major approaches and in subsequent pieces, we will identify the best and worst that this fund complex has to offer with regard to SRI/ESG investing.

Their original approach is named the “Calvert Signature Series” and combines financial metrics and a thorough assessment of environmental, social and governance performance.

They have the typical exclusion list that includes to some degree in most of their core funds; tobacco, firearms, alcohol and human rights issues. The also engage in an advocacy approach that focuses on four major areas of strategic priority.

  • Environment and climate change
  • Governance and ethics
  • Diversity
  • Human right, labor and indigenous people’s rights

Within this mandate they have funds that cover domestic, international as well as a bond portfolio. They also have “allocation funds” although as a matter of philosophy, we do not believe in their use.

Calvert expanded their offering to include a more thematic mandate named, “Calvert Solution Strategies” whose portfolios selectively invest in companies that produce products and services geared toward solving some of today’s most pressing sustainability issues.

The Calvert Global Alternative Energy Fund advocates mainly for renewable energy while the Global Water Fund advocates in the areas of equitable and affordable access to water, climate change and stakeholder engagement.

While some emerging markets funds focus on dividend yield or pure growth rates, Calvert looks for companies that aim to address global sustainability challenges in their local and or international markets.

The third major approach is their enhanced engagement approach named their “Sage Strategies”. These portfolios emphasize strategic engagement to advance environmental, social and governance performance in companies that may not meet standards today but have the potential to improve.

Within the environmental area they look for reporting and reductions with regard to greenhouse gas emissions and climate change public policy. Their governance screen and advocacy focuses on diversity as well as revenue transparency, policies and engagement.

They offer two equity funds within this area in an equity income fund and a large cap fund.

There are a number of SRI/ESG criteria to consider at the firm level and for your individual clients who may have certain beliefs that are contrary to a fund constructed based solely on financial metric screens.

The next SRI/ESG piece will assess and score a few of the funds within each category to aid firms in their decision to expand into this growing area of the investment world.

Sincerely,

Tom Koehler-CIO

 

“Socially Responsible Investments represent a complex asset class and while we covered a small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”

 

 

 

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Inflation Indexed Notes-Piece Three in our Four Part Series-Actively Managed Fund Review

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In our last piece we reviewed a few ETF options and laid out a basic framework on the various possibilities available to a firm that would like to gain exposure to inflation indexed notes. In this piece we describe a few active managers that hold a significant amount of assets so they can be thoroughly vetted by investment committees at traditional Wealth Management firms, Family Offices and pension funds.

 

ACITX – American Century 3.2Billon in AUM

Investment strategy-Inflation-Adjusted Bond Fund is actively managed to help investors combat the corrosive effects of domestic inflation through holdings in mostly high-quality, inflation-indexed bonds.

Risk (s): In certain interest rate environments, such as when real interest rates rise faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities.

Risk-adjusted Statistics – They are not impressive enough for a placement. Also the statistics are reasonably inconsistent among their own website, Morningstar as well as another provider. Overall their MPT stats are underwhelming for a fund with 4 portfolio managers.

Characteristics

  • The duration allocation is reasonably benchmark constrained.
  • They attempt to generate extra returns through yield curve trades.
  • The funds’ flexibility allows up to 20% in corporate bonds and MBS (investment grade only). However, they can engage in a swaps overlay program with these assets with strict risk controls.
  • This funds’ performance is not impressive enough to warrant a conviction placement.

 

Process and overall assessment

The process is reasonably constrained in a domestic only mandate and a value added proposition is lacking. Given the fees and the size of the management team, there should be more evidence in the ability to consistently beat the index. This fund is not worthy of investment dollars as it does not meet the criteria threshold for an active manager.

Zenith Score-Low

 

VIPSX – Vanguard 25.9 Billon AUM

Investment Strategy

Exclusively invests in U.S. TIPS and only makes changes with regard to small tilts in duration. Their only differentiation or competitive advantage is through their low expense ratio. They attempt to closely track the benchmark.

Risks

In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. Being an exclusively U.S. TIPS fund, Vanguard insulates themselves from outside country risk but retains US inflation risk.

Risk Adjusted Stats: They are not impressive enough for a placement. Also, the statistics are consistent with a fund that hugs a benchmark. Overall their MPT stats are underwhelming for a fund that is part of such a large fund complex.

Characteristics

  • The duration allocation is benchmark constrained.
  • They attempt to generate extra returns through bond price inefficiencies and changes in inflation.
  • The funds’ flexibility allows up to 20% in corporate bonds and nominal Treasury notes (investment grade only). However, this flexibility is rarely exercised.
  • This funds’ performance is reasonable vs. mutual fund competitors.

 

Process and Assessment

This fund is worth consideration if a firm simply wants exposure to mainly the US TIPS market with the chance for marginal value added. We will examine in the comprehensive part 4 of the 4 part series this fund and try to determine if it holds up against passive and active ETFs.

Zenith Score-Low to Medium

 

PRIPX – T Rowe- $342 Million AUM

Investment Strategy

T Rowe invests the majority of their assets in TIPS with 92% in U.S. TIPS. They attempt to achieve alpha through small over weights in corporate bonds and a small allocation to non-U.S. TIPS bonds in countries like Canada and Mexico.

Risks

In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. This fund also has exposure to foreign TIPS debt which creates country risk.

Risk Adjusted Stats- They are not impressive enough for a placement. Also, the statistics are consistent with a fund that hugs a benchmark. Overall their MPT stats are underwhelming for a fund with the resources that T-Rowe possesses.

Characteristics

  • The duration allocation is reasonably benchmark constrained.
  • They attempt to generate extra returns through over and underweights to various portions of the yield curve.
  • They are able to invest in fixed-income securities that are not indexed to inflation or in preferred stocks and convertible securities rated A or better.
  • The manager may also allocate to inflation-indexed securities in non-U.S. markets that we feel offer more attractive real yields and inflation dynamics versus their U.S. counterparts. This is currently only at approximately 3%.

 

Process and Assessment

T Rowe has not achieved standout returns for the somewhat higher fees in spite of the yield curve and geographical flexibility.

We recommend that an advisor look elsewhere as the excess returns are simply not present and the flexible process while generally appealing, does not impress us to be confident in the future to navigate the inflation indexed notes market.

Zenith Score-Low

 

FINPX-Fidelity- $2 Billion AUM

Investment Strategy: Normally investing at least 80% of assets in inflation-protected debt securities of all types. Normally investing primarily in U.S. dollar-denominated inflation-protected debt securities. Engaging in transactions that have a leveraging effect on the fund.

Risks: In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities.

Risk Adjusted Stats: They are not impressivefor a fund complex of this sizethat should have the resources to engage in a more robust process.

Characteristics

  • The duration allocation is reasonably benchmark constrained.
  • They attempt to generate extra returns through over and underweights to various portions of the yield curve.
  • They are able to invest in fixed-income securities that are not indexed to inflation or in preferred stocks and convertible securities rated A or better.
  • The manager may also allocate to inflation-indexed securities in non-U.S. markets that we feel offer more attractive real yields and inflation dynamics versus their U.S. counterparts. This is currently only at approximately 3%.

 

Process and Assessment

Fidelity has an average process that does not do enough to place enough faith into this team for the future nuisances of  the inflation indexed note market. At best we believe this fund can perform in line with the benchmark and the category.

 

Zenith Score-low

 

PRRIX- Pimco Real Return Strategy $15 Billion AUM

Investment Strategy

This fund seeks to outperform its benchmark (Barclays Capital U.S. Treasury Inflation Notes: 10+ year) by accumulating assets with maturities that are longer than the average TIPS funds. The fund also has exposure to non U.S. TIPS funds in Emerging markets and non-U.S. developed in an attempt to gain additional real return over the benchmark.

Risks

Pimco takes on additional risk compared to their peers in this asset class given their exposure to non-U.S. debt, as well as small positions in commodities and corporate bonds. In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities.

Risk Adjusted Stats-Reasonable statistics in a tough investment class. They may have achieved this during times of high interest rates and made solid calls with regard to duration. It may be a tougher market in the future.

 

Characteristics

  • It is reasonably duration allocation benchmark constrained although they do take active bets as much as they can.
  • They attempt to generate extra returns through leverage and duration management as well as through investments in non-US TIPS.
  • Flexibility to invest up to 20% up assets in corporate bonds and MBS (investment grade only)
  • They have had a higher standard deviation than peers in the past.

 

Process and overall Assessment

While we appreciate their deep macroeconomic expertise, the returns are not as compelling as we would like from an active manager. The ability and willingness to invest globally is appealing although we will examine in our next piece this funds viability when stacked up against passive investing and its own active ETF.

Zenith Score-Low to Medium

 

Our overall impression is that most actively managed mutual funds are not capable of regularly adding value above the US centric Inflation Indexed Notes Index. The opportunity set is limited to a heavy overweight in US Tips which may or may not be a solid performing asset class. In part, these funds assets ballooned in assets as the inflation indexed market grew. Early on it seems the largest portion of the inflation notes market was found in the US.

That has resulted in approximately $44 Billion sitting in these active funds that arguably have a limited mandate. As described above, some are able to manage the duration as well as geographic placement although the results are only marginally better or worse in most cases.

A question remains. Are these managers simply victim to a stagnant and US centric asset class? Should investors be satisfied with the risk and return stream that most of these managers provide or should they seek greener pastures with a manager or ETF with a more flexible and dynamic opportunity set and mandate. Given the massive amount of capital in these funds, we highly recommend that firms look at alternative solutions and really delve into their real return exposure.

In part four coming out shortly, we will review and tie together the themes in the first three pieces. We will begin with an inflation overview along with our favorite exposure to this asset class. It is possible that TIPS are too limited and that a more robust instrument with a wider mandate that includes additional asset classes sensitive to inflation may be the answer.

In the meantime, please take the time to examine your current Inflation Indexed Notes exposure and especially determine if the fees are worth having an active manager.

Sincerely,

Tom Koehler-CIO

 

“Bond markets represent a complex asset class and while we covered a small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”