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Can traditional fixed income funds have a social impact – regardless of their mandate?

29 Oct 2020

Angelique Kalam / Manager: Sustainable Investment Practices

Article

We are often asked if it is possible to have social impact exposure in fixed income funds that do not have a social impact mandate. In our experience, yes it is.

Most of the funds we manage, even vanilla core bond and yield enhanced bond funds, have an element of social impact exposure. This is a natural by-product of our investment philosophy and process - and we consider it to be an added value.

Futuregrowth has a 25-year history of investing in developmental impact funds, and managing these complex investments has shaped the way we choose to invest. As an asset manager, we have focused on sectors that promote and facilitate social and infrastructure development while still ensuring that our client funds earn an appropriate risk-adjusted return. We also have the advantage of economies of scale when we invest on behalf of clients, and have developed a fair allocation process to manage the apportionment of deals.

Our Responsible Investment philosophy and approach

Being a responsible investor is the cornerstone of our investment philosophy - and our approach to assessing risk is applied to all portfolios and client funds across the risk spectrum funds.

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As it is our primary objective to earn appropriate risk-adjusted returns at all times for our clients, it is necessary that environmental, social and governance (ESG) screening and analysis form part of an integrated investment process across our wide range of mandates. In this way, non-financial ESG indicators are assessed along with financial and credit indicators in order to produce a holistic risk profile of any new or existing loan, at a given point in time. We use a variety of tools and inputs for this purpose, and these are constantly fine-tuned as new learnings arise. The fixed income asset class is complex due to the wide variety of issuers, and we have found that there is no ‘one-size-fits-all’ solution to analysing companies on sustainability issues. 

Fair allocation

Futuregrowth manages an array of assets across fixed income, ranging from money market, vanilla and inflation-linked bonds to high yielding credit bonds, and a suite of developmental impact funds across a variety of asset classes.

We conclude investments across diverse sectors, from financial services to commercial property and more, as well as a variety of social impact sectors, from affordable housing to renewable energy etc.

So how do we decide to allocate deals to funds, and how do we ensure that no cherry picking occurs in this process? This is achieved through our internal ‘fair allocation’ process. It must be reiterated that all investments are concluded on a commercial risk-adjusted basis and their return merits.

Once our respective credit or investment committee approves an investment, we follow a fair allocation process that filters investments and allocates them to the portfolios according to each portfolio’s respective mandate limits.

The fair allocation process follows these principles:

1. Be fair to all clients

2. First bite rules:

  • Ensure that funds with a limited universe get allocated first
  • Provide an equal allocation across all funds within a similar product range
  • Ensure consistency of performance for all funds in a particular GIPS composite

3. Scaled allocation according to the risk appetite of that product range:

  • Ensure there is relative risk taking across different product ranges

4. The allocation is fee agnostic

5. Portfolio-specific adjustments allowed:

  • Adjust for mandate compliance (e.g. hitting limits)
  • Adjust for administrative constraints (e.g. minimum issue size, cash availability).

Example 1: Allocation of an affordable housing deal to a variety of portfolios

The illustration below demonstrates how a R100 million affordable housing investment was allocated to a variety of client portfolios according to their respective mandate limits. (In this example we used a small segment of portfolios for illustration purposes.) Since the investment has a social or developmental impact (it will address the affordable housing shortfall and facilitate access to funding to SMME’s), the impact funds had first bite in the process due to their mandate requirements.

Following the first bite rules, if the transaction is sizeable and the full amount is not allocated to the impact funds, in this example the Futuregrowth Infrastructure & Development Bond Fund, then the transaction is also apportioned across various other client portfolios within their mandate limits and capacity for the investment. The sequence in which the allocation was made to each portfolio is indicated by the numbers in the illustration.

In this way, it is not unusual for the non-impact funds (Yield Enhanced Bond Fund and Core Bond Fund) to have exposure to high impact investments such as affordable housing. This demonstrates the effectiveness and value of the fair allocation process.

effectiveness and value of the fair allocation process

Example 2: Comparison of three funds with different mandates

The table below compares the overall exposure of the three portfolios used in the previous example. Column 1 shows our flagship impact bond fund, the Futuregrowth Infrastructure & Development Bond Fund, which has a total of 60.30% exposure to a range of infrastructure and developmental sectors. In comparison, you can see that the Yield Enhanced Bond Fund in Column 2 has 48.58% exposure, and the Core Bond Fund in Column 3 has 12.20% exposure, to infrastructure and developmental sectors - even though these funds in columns 2 and 3 do not have a specific impact mandate. This exposure arises due to the fair allocation process.

Table 2: Futuregrowth Infrastructure & Development Bond Fund vs Yield Enhanced Bond Fund vs Core Bond Fund 

Futuregrowth Infrastructure & Development Bond Fund vs Yield Enhanced Bond Fund vs  Core Bond Fund
Data as at 30 September 2020

Exponential value

Our economies of scale, together with our preference for sectors that promote and facilitate social and infrastructure development, means that more of our client portfolios, have exposure to sectors and businesses that promote economic and social upliftment while still earning an appropriate risk-adjusted return for the funds. These investments in education, health and infrastructure facilitate job creation and social upliftment, which contributes to a more sustainable future for all.

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