Environmental, social and governance (ESG) investors are increasingly excluding the kind of government debt that is the mainstay of most retail and institutional and even national portfolios worldwide.
Both US treasuries and UK gilts can, for example, fall foul of the criteria governing many such strategies.
Hawksmoor Investment Management has made it clear that when it comes to ESG it rejects US treasuries and does not believe funds that include US government paper meet the criteria for an ESG portfolio due to human rights and climate change concerns.
The ethics of US treasuries
Hawksmoor chief investment officer for private clients Jim Wood-Smith says: “On treasuries, we think managers of ESG funds should try and be as consistent as they can with the rules and apply them to countries as well as to companies. Precisely the same rules should apply to countries as to corporates.”
“If you have a government that is an open manipulator of the Geneva Convention and is a denier of climate change, which the US effectively became by pulling out of the Paris COP 21 agreement – were that to be a company – those would be two big red flags and they would be excluded.
“You can say lots of good things about the US government as the home of global democracy but it has two big red flags on human rights and climate change. That means US treasuries are an asset class that we do not want to see in ESG funds.
“If you are applying ESG rules, US treasuries are a non-qualifying asset. Should a future US government decide it is going to close Guantanamo Bay and come back into COP 21, they then become a qualifying asset again. Until then they get a ‘whack, whack oops!’”
Western democracies are fair game
Wood-Smith adds that for those worried about the make-up of portfolios, that there are other assets.
“If you are looking for an asset to do a similar portfolio role, you have a trawl around triple A and double A rated bonds. They are going to do exactly the same thing in your portfolio.”
Not all experts agree.
Square Mile Investment Consulting and Research head of investment Jason Broomer says: “ESG considerations are very much a subjective issue, and I think an adviser must make the call on behalf of themselves.
“Personally, refusing to invest in a Western democracy’s bonds on this basis of undesirable governmental policies seems extreme, though others may disagree. I think you need to define which ESG considerations you wish to avoid whether arms sales, tobacco, environmental. Then you need to consider the degree of exposure, for example no BAT or Imperial Tobacco, but what about Tesco which makes money from selling tobacco?”
UK government fails on ethical screens
Rathbones eschews UK gilts in its Ethical bond fund although it believes that action by the UK treasury could see it amend this approach.
Noelle Cazalis, assistant fund manager, Rathbone Ethical bond fund (pictured) says: “We cannot buy UK gilts in the Rathbone Ethical bond fund simply because they do not pass our ethical screening process, which excludes armament and high impact activities such as nuclear power. In order for us to consider investing in such securities, we would need the monies from a bond to be ring-fenced for projects that meet our fund’s criteria.
“We would like to see the Treasury engaging more with ESG investors to see how the growing investor’s demand can be met. Green bonds have been mentioned by investors several times.”
Reducing portfolio risk through screens
Yet short of action by the treasury departments either side of the Atlantic, what do advisers think?
Alan Chan, a chartered financial planner and director with IFS Wealth and Pensions says: “This is quite a common theme with ESG funds. Government bonds typically do not meet the ESG criteria and they cannot effectively engage with the government to change their behaviours and certainly not in the same way as companies, so they tend to be excluded from the portfolio completely.
“Personally, I don’t see this being much of an issue and in some cases, it has benefitted the ethical fund themselves as they have avoided riskier gilts, such as emerging market government debt, as in the case with the Rathbone Ethical bond fund. Also, there are other assets that can be proxies to gilts, such as other fixed interests, high-yield, alternatives, or even some equities.”
A watershed moment for responsible investing
Nick McBreen, IFA with Worldwide Financial Planning, says: “In my opinion this highlights what may indeed be a bit of a watershed in the investment space, whereby fund managers are increasingly looking or being made to look even more closely at where their funds are investing. We know that investors are becoming more demanding about where their money is utilised and so putting the political goggles on when evaluating government bonds is surely in line with the gathering momentum for ESG friendly funds.
“The whole fixed interest and bond space has seen very difficult conditions over recent years and when political stories and scandals hit the headlines more and more frequently it can be no surprise that investors who are also likely to be voters start to make their views felt, although investors need to be on their mettle to be mindful of not making decisions driven by fake news and scaremongering!”
Insight from Thomas Hobbes
Graham Bentley, managing director, gbi2 is philosophical, before considering the practicalities of managers’ and advisers’ approaches.
He says: “Thomas Hobbes would have argued that governments or democracies at least have a responsibility for the well-being of their citizens as their end of the social contract whereby individuals accept the authority of the state in exchange for certain benefits. One could argue those are protection via the law, provision in terms of infrastructure and the welfare state and investment helping individuals’ ability to provide for themselves with education.
“Governments borrow in order to fulfil those obligations. Lenders are free to lend their excess capital to whoever they like. Where citizens’ protection is perceived as being eroded as with the Paris agreement, climate change, Guantanamo etc, lenders with ESG parameters are doing their job by choosing not to fund that activity.
“As for advisers’ attitudes, they have the further issue that their clients may not have the same concerns. Consequently the adviser’s principles would have to be declared within their investment proposition (so for example their adherence to ESG principles) and selections made accordingly. Advisers can also choose simply to be indifferent, servicing the principles of investors on a case by case basis, i.e. providing ESG portfolios framed as a product solution.”