The manager of Rathbones' $2.4 billion Ethical Bond Fund is beating her benchmark – and 95% of her peers. Here's how she makes green investing work.

  • Rathbones Ethical Bond Fund manager, Noelle Cazalis, tells Business Insider the strategy behind her 95th percentile returns.
  • Companies must be considered solid investment cases before considering the ethical positives, Cazalis says, ensuring you are always investing in the best.
  • Social housing bonds have been a particular success in the portfolio, Cazalis says, and that looks set to continue 
  • Visit Business Insider's homepage for more stories.

Green and ethical investing is rapidly becoming a hot topic – but while this might be a relatively new trend for equity investors, it has been a staple in the fixed-income universe for many years. Ethical bonds have been a golden goose for many companies and governments looking to stabilize their balance sheets throughout the coronavirus crisis.

The European Central Bank, under the supervision of its president, Christine Lagarde, has led from the front with green bond buying programs and the issuance of social bonds – known as SURE bonds. This year, even emerging-market countries such as Egypt have issued a green bond. 

But for some investors this isn't a new phenomenon, it is simply the next chapter. This is certainly true for Noelle Cazalis, a fund manager of Rathbones' £1.8 billion ($2.4 billion) Ethical Bond Fund, launched in 2002, by veteran fixed-income investor Bryn Jones.

Alongside Jones, Cazalis has consistently beat her benchmark – the iBoxx Sterling Non-Gilts Overall Total Return Index – returning 6.43% over the last five years, versus the index's 5.56%. Her fund's returns compare to an average of  1.77% for her competitors, which places her in the 95th percentile, according to data from Bloomberg.

"We've outperformed the sector with a lower level of volatility. We are one of the funds that has – over five-years – the highest Sharpe ratio in the sector," Cazalis said.

The fund, which invests solely in ethical corporate investment-grade credit, differentiates itself with a "flipped" investment process compared to its peer, according to Cazalis.

"The ethical screening has to come at the end," she said, "because we want every investment in the fund to stack up from an investment standpoint, not just because it's nice and green and it's doing some good… I think that's key in the way we manage the fund."

This doesn't diminish the ethical quality of the fund's investments, but it does create a strong investment pitch for the team to apply its process of exclusion, eliminating bonds that don't meet Rathbones' standards.

What makes the cut? 

As you would expect, the fund doesn't invest in any company that may have "exposure to animal testing, tobacco, alcohol, pornography, high-impact activity," Cazalis said, and once you have that, "you get your investment universe."

But Cazalis goes further. "We don't stop at the exclusion level at Rathbones, a company needs to have no negatives, based on our criteria, but also at least one positive. So we do that a kind of extra step and that is the positive screening," she explained.

With this process of detailed exclusion, Cazalis can invest in bonds, even if they are not labelled as green or ethical. "For us, because we have exclusion in our fund, we don't really need a company to issue a green bond," she said. "It doesn't mean because it's labeled, it can go into our fund and it doesn't mean because it's not a green bond that it doesn't have really green characteristics."

One example is the fund's investment in Greater Gabbard, where it finances the pipe of an offshore wind farm. "It's not called a green bond, because they didn't want to label it as such, but in terms of what it's trying to do… it is something that we would consider," she added.

But, for Cazalis, the fund's ethical standards make for better investments generally. Having joined Rathbones as a credit analyst, the ESG process "absolutely makes sense."

She continued: "Why wouldn't you take into account environmental risk, social risk and governance risk? They are risks at the end of the day and they can really impact your cash flow, therefore they can really impact the yield that you get on your investment and your return… the more risk you can take into account, the better."

The fund has had some particularly successful investments, according to Cazalis, who highlighted credit investments in social housing, which account for just under 7% of the fund's allocation, according to the Rathbones website.

When Cazalis first joined in 2011, Britain was in the throes of an austerity regime, meaning that grants for social housing associations were being cut. Therefore, associations "had to find new sources of finance and a lot of them turned to the bond market," she added.

These were strong single-A rated investments, with some bonds even secured on social housing stock, she said, providing strong cash flow and security. "They've been quite a big theme in the portfolio and we see more and more of this housing association coming to the market," she added.

The second winner for Cazalis has come from so-called Liability Management Exercises (LMEs), adding to the "alpha generation of the fund."

The regulation in financials, in both banks and subordinated insurance papers, has changed a lot. Therefore some of the bonds are becoming obsolete, but yet they still carry a five or a 6% coupon, Cazalis explained. "So what we've done is identified the bonds that we think will be tendered early and redeem them at a premium to market prices and invested in that," she added.

With the UK announcing on Monday that "green gilts" will be issued in 2021, the green bonds story has only just begun. They are now "very established, more standardized instruments and really every treasury department and every company should look at them as they look to raise money for new projects," Cazalis concluded, saying that the US Treasury could even issue a green bond in 2022.

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