“Most of our underperformance in the first two years of the fund can be explained by our decisions rather than our ethical mandate, I wouldn’t blame the screens for it,” he said.
Five crowned Kames Ethical Cautious Managed is a top-quartile performer in its IMA Mixed Investment 20%-60% Shares sector over one, three and five year timeframes, despite being severely constrained by ethical screens that make entire sectors uninvestable.
However, data from FE Analytics shows that it wasn’t always plain sailing.
Performance of fund versus sector over 5yrs
Source: FE Analytics
The fund underperformed its sector average in 2008, and Buckle says the reason was simple.
“We had too much exposure to low-rated credit,” he said, adding that he is far more cautious in his approach today.
Buckle runs the fixed interest side of the portfolio, with Audrey Ryan responsible for picking equities.
He says that their investment decisions, not the effects of ethical screening, are responsible for the success of the portfolio.
“One of the ways we try and add value is through asset allocation. Overlaying an ethical criterion doesn’t have much of an impact on deriving value from that source. To an extent last summer we became more bearish on equities and built up our cash, but the asset allocation hasn’t changed hugely.”
“The biggest driver of performance has been stock selection. Within the equity portfolios we have to say there are times in the market when the market is beneficial to an ethical portfolio in terms of the parts of the market that are doing well and others when it’s against us, but over the longer term it tends to wash out.”
The biggest problem facing the managers, Buckle explains, is their inability to invest in the UK commercial banking sector.
The fund is barred from investing in arms manufacturers, the governments that fund them – meaning no government bonds – and the banks that lend the money for the purchases.
“This leads me to building societies for financial exposure such as Nationwide, Coventry Building Society, the Co-op,” he said. “If we had a broader remit we would have alternatives.”
“When the markets is doing well we can struggle to keep up because a big part of the index is banks.”
He continued: “Large portions of the defensive sector are uninvestable – tobacco, pharma and alcohol – so Audrey needs to look for alternatives to those. We can’t invest in 30 per cent of the FTSE 100.”
“We think we are probably the most restricted in terms of our available universe,” he finished.
Ethical screening is often criticised for the fact that ethical priorities can vary from person to person and can change over time.
Buckle says that he believes the benefit of Kames’ negative approach – screening out sectors – is its clarity.
“It’s very difficult to successfully articulate what you are selecting with a positive screen,” he said.
“We hope the screens match with what the majority of people want and expect, but we are aware that people have different ideas and all we can do is set up screening,” he added.
“We do have feedback. Every two to three years we go out to clients and ask if they think the rationales behind our screens are still relevant and we try to us that to capture the new themes in the market, so our screens are never set in stone.”
This article was written in collaboration with and is sponsored by Ecclesiastical Investment Management.