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8/8/2022
7
min read

ESG - Many puddings are in the oven, and we’re waiting for the proof

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Roger Lewis
Roger Lewis

Head of Sustainability and Responsible Investing

Downing launches new actively managed liquid alternatives fund aiming to deliver 7% to 10%+ per annum and positive returns in most markets. The new MGTS Downing Active Defined Return Assets Fund (‘Active Defined Returns’, the ‘Fund’), is the first fund from its new Liquid Alternatives team.

The Fund is aimed at institutional investors, Discretionary Fund Managers, IFAs and advised sophisticated individual investors, and will primarily consist of UK Government bonds and large-cap equity index options, which provide significant scalability and strong liquidity. It aims to deliver 7% to 10%+ per annum and positive returns in all markets except for a sustained equity market fall (generally more than 35%), over a period of at least six years.  

The Fund is the first to be launched by the new Liquid Alternatives Team established by Downing. Collectively, the team has over 125 years of experience and sector knowledge, and includes Tony Stenning, who held senior roles at BlackRock and most recently was CEO of Atlantic House Group; Russell Catley, founder and also a former CEO of Atlantic House Group; Huw Price, a former Executive Director at Santander Asset Management, and Paul Adams, former Head of Cash Equities and Derivatives Sales, Royal Bank of Canada.          

The Fund offers investors a compelling building block for multi-asset portfolios, aiming to add consistent and predictable returns, typically secured with a portfolio of UK Government bonds. The unique proposition includes a hybrid approach of using systematic derivative strategies and active management, combining liquid investments with predictable returns, and an equity like risk profile.

Investment strategy: Maximising the probability of delivering predictable defined returns across the economic cycle.

  • Systematic Liquid Derivatives:  Systematic, derivative strategies optimise the equity risk-return profile. The Fund uses rules-based derivative strategies linked to the most liquid, large-cap global equity indices (i.e. FTSE100, S&P500) with the aim of harvesting well-proven consistent returns across a wide corridor of market conditions. 
  • Strong security:  The Fund will hold a high-quality portfolio of assets as secure collateral – typically UK Government bonds.
  • Active benefits: At times, rules-based, passive derivative strategies can underperform when markets move strongly – this is when specialist active management can add incremental gains by monitoring and monetising positions and applying active risk management.

Key benefits

  • Increased consistency and predictability of returns: Positive returns in all markets except for a sustained equity market fall of more than 35% over at least six years.
  • Diversification of risk: The Fund’s risk components are diversified across large, liquid equity indices, observation levels and counterparties. Secured with high-quality assets – typically UK Government bonds.
  • Active management: Our experienced team will actively manage the Fund and its investments to optimise risk and reward for investors.
Russell Catley, Head of Retail, Liquid Alternatives at Downing, said: “Put simply, we focus your investment risk on the probability of receiving the returns you need, not those you don’t.  We target the highest probability of delivering 7% to 10%+ per annum with active management adding material incremental gains. We believe that we are building the next evolution of the proven success of Defined Returns funds
The Downing team is seeing strong demand from clients looking for alternatives to large-cap equity funds which are becoming concentrated in technology stocks, or alternatives to UK equity income funds and illiquid alternatives.”   
Tony Stenning, Head of Liquid Alternatives at Downing, said: “The launch of our Active Defined Return Assets Fund is a significant milestone in the ambitious build-out of our new Liquid Alternatives strategies. It is a solution-focused fund that should deliver stable high single or low double-digit returns across a wide spectrum of equity market conditions, except for a persistent multi-year bear market. The Fund is designed to enhance balanced portfolios by providing consistent, predictable returns and is suitable for accumulation or drawdown.
“We aim to deliver a unique combination of proven systematic derivative strategies and specialist active management, and we are doing so at a very compelling fee level, below our closest competitors and in line with active ETFs.”

How the Fund is expected to perform in different markets

  • In bullish markets:  UK Government bonds secure the capital, and the equity index options deliver a predictable 7-10%+ return per annum – giving up some less likely upside.
  • In neutral markets and normal market corrections:  UK Government bonds secure the capital, and the index options deliver a predictable 7-10%+ return per annum.
  • In a sustained sell-off:  if markets fall more than the cover to capital loss and do not recover for six years. Then capital is eroded 1:1 in line with the worst performing index.
  • The average Cover to Capital Loss is targeted at 35%:  the average cover to capital loss represents the average level the Global indices within the Fund could fall before capital is at risk.

Fund key risks

  • Performance:  Capital is at risk. Investors may not get back the full amount invested.
  • Liquidity:  Access to capital is always subject to liquidity.
  • Counterparty risk: Other parties could default on the contractual obligations.

Fund Structure

  • UK regulated OEIC fund structure, fully UCITS compliant
  • Daily dealing, at published NAV
  • Minimum investment: £100,000
  • SRRI: 6 out of 7
  • Depositary: Bank of New York
  • Authorised corporate Director (‘ACD’): Margetts Fund Management Ltd.
  • I share-class:  SEDOL: BM8J604 / ISIN: GB00BM8J6044
  • F share-class: SEDOL: BM8J615 / ISIN: GB00BM8J6150

Learn more about the Fund here.


Risk warning: Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please refer to the latest full Prospectus and KIID before investing; your attention is drawn to the risk, fees and taxation factors contained therein. Please note that past performance is not a reliable indicator of future results. Capital is at risk. Investments and the income derived from them can fall as well as rise and investors may not get back the full amount invested. Investments in this fund should be held for the long term. 

Important notice: This document is intended for professional investors and has been approved as a financial promotion in line with Section 21 of the FSMA by Downing LLP (“Downing”). This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. Downing is a trading name of Downing LLP. Downing LLP is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England and Wales (No. OC341575). Registered Office: 10 Lower Thames Street, London EC3R 6AF.

Environmental, social and governance-related investing

It’s time for a stock take. Environmental, social and governance-related investing is hot on the lips and touted as a key component in mitigating climate change. Downing’s Head of ESG, Roger Lewis, reviews progress from the first half of 2022.  

There are two things to remember from the first half of the year: progress continues and the destination is still quite a distance away. 

Net, not gross, zero carbon 

Coming up to three years of age for some asset classes, multiple methodologies and targets have been released for the 2050 target of net zero carbon emissions for investments.  This ranges from the first wave of the largest asset managers committing to the Net Zero Asset Management Initiative (NZAM) just before COP26, to the fifth wave of signatories that brought the total committed to the NZAM up to $61 trillion of total assets under management (AUM). 

Despite this large total, data published in the first half of 2022 from the UN Environment Program Finance Initiative and IPCC showed that net zero asset manager commitments are yet to deliver meaningful emissions reduction. Total emissions from human activity in 2021 did not trend downwards and instead rose slightly above the 2020 level of 60 billion tonnes of carbon dioxide equivalent. Furthermore, another two parts per million of greenhouse gases (GHG) were added last year, meaning there are more molecules in the atmosphere that trap heat. 

There has been progress on commitments, targets and reporting, though little on real-world emissions. To achieve urgency, data needs to be collected for each asset within a fund and then a steep and comprehensive reduction of emissions. We have often seen that voice (engagement) is preferred over exit (divestment), so to achieve integrity, carbon removal or sequestration should be considered for cumulative and new emissions.  

Carbon offsets ought to be used only at the end for the small remaining emissions that an investor or company is responsible for. Given the ‘wild west’ and ‘price is too low’ criticisms that offsets receive, there has been some debate in the first half of 2022 about regulated markets, similar to other financial instruments.  

The green energy transition 

A close relation to net zero is the green energy transition - the UK, EU and US have been particularly active in this area so far this year. 

The UK Committee on Climate Change published its annual critique on the UK meeting its legal decarbonising obligations under the 2008 Climate Change Act. Some areas show good progress: credible emissions reduction plans for two-fifths of the target and a solid net zero strategy that covers power, oil & gas, industry, transport, heat and buildings. Others do not: no plans relating to emissions reductions in some sectors and policy gaps for land use and energy efficiency.  

Relating to the EU, Brussels has laid out many supplements to the Green Deal strategy. This includes committing to spend on research & innovation in climate-tech and clean-tech, and also accelerating the blended finance partnership between public and private investment. 

The EU also announced the newly commissioned RePowerEU Plan, which will reduce energy dependency on Russian fossil fuels - important progress that will aid European energy security and tackle climate change. However, the debate surrounding the carbon border tax on imports such as steel from India continues. 

The US is the second largest emitter of GHGs after China and is home to the world’s largest companies. The U.S. Securities and Exchange Commission’s Climate Disclosure Rule draft introduced in April 2022 was therefore a milestone. With the introduction of this rule, just like audited financial statements are a legal requirement, audited GHG emissions will now need to be disclosed by companies. While not final yet and subject to consultation and lobbying, the rule nonetheless provides clear signalling of the regulator’s position on climate disclosures. 

Research making leaps forward 

Throughout the year, scientists on the Intergovernmental Panel on Climate Change published their latest research findings in the sixth assessment report, or AR6. The research benefits from greater accuracy due to technological advancements, which include computer simulations, satellite measurement for methane, ground weather stations and probes to record GHG concentrations in ice when it was frozen. 

Crucially, confidence ranges are much narrower now than AR4 and AR5 - the previous iterations of AR6. The impacts of extreme weather are more visible and better understood, to the degree that denying the science of climate change can be likened to believing cigarettes are extremely good for health.  

As always, these regulatory developments are important steps toward giving investors the ESG information they need, but do present both risks and opportunities.  

Energy cannot be created or destroyed, just moved from one place to another 

This rule of energy introduces a real risk to net zero and the green transition and has already been observed this year.  

Consider a global oil company, let’s call them Bones & Plankton plc (or BP for short) - a nod to the ancient life which has been formed over millions of years into hydrogen and carbon, known as fossil fuels. BP wants to impress customers, attract talented staff, avoid fines and alleviate the board and management’s guilt for past high emissions.  

It undertakes a large asset disposal programme: selling shale gas deposits in the south-western US Permian Basin, oil tar fields in Alberta and part of a gas pipeline in Turkey. The buyers are hedge funds, sovereign wealth, private equity and national oil companies. 

Has this benefited the environment? The emissions will continue with the new owners, but now they will not be disclosed. Investors, as providers of equity or debt, usually have the ability to engage or vote to remove these emissions. Now the company has disposed of these fossil fuel-intensive assets, that ability has been eliminated. 

Have you been mis-sold an ESG fund in 2022? 

Another hot regulatory topic is combatting the greenwash and the over-representation that can happen when investors are not required to disclose their impacts or when sustainability data from companies is not available. 

This is met via EU directive 2019/2088 (November 2019) from the European Supervisory Authorities that regulate asset managers, banks, insurers and pensions. Or, as it’s better known, SFDR. 

The benefits are clear: allowing an approved fund that can be sold as ‘green’. Demand for these funds from asset owners– labelled as ‘Article 8 or 9’ – is high. And investments can range from European and emerging market equity to UK infrastructure.  

In addition to many Article 8 and 9 fund launches, progress has been made embedding an understanding of all the articles within the SFDR Regulatory Technical Standards, and internal preparations to meet these obligations across various functions at an asset manager.  

The SFDR pudding will be ready in early 2023. In the meantime, SFDR ensures financial market participants will report on sustainability impacts, evidence taxonomy alignment, do no significant harm and provide further updates on the sustainable objectives that investors have bought into.  

Post-Brexit, investors and a technical group advising the UK government debated the UK’s equivalent to sustainable finance regulation and a green taxonomy. More is expected on this later in the year.  

Nature is an asset… 

…with a value, just like equity, real estate, machinery and so on. In order to mitigate climate change, people are realising they also need to consider waste, land use, water, the carbon capture properties of soil and trees, the blue economy and natural ecosystems. The concept of net environmental gain is becoming better understood and prompting institutional clients to question what investors are doing in this space.  

Next year, new reporting based on the Taskforce for Nature-related Financial Disclosures or TNFD (a close relative of the established Taskforce for Climate-related Financial Disclosures) is scheduled to be released. As companies disclose information, investors can use this in investment and engagement decisions. Some metrics can be universal, like dollars spent on the protection of habitats or the number of a particular species. Others are unique like urbanisation, illegal wildlife trade and habitat destruction.  

So, in all, some progress in the first half of the year. TNFD and the upcoming UN Biodiversity Conference in Montreal in December will be important steps toward nature being treated like any other asset in future.   

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