Our approach to diversification
Strengthen resilience and target opportunities across a wide range of asset classes.
We believe that investing in a wide range of asset classes will result in more consistent performance across a wide range of economic conditions and help deliver better outcomes for your clients.
The Governed Range holds a broad mix of assets - for example: company shares, bricks and mortar property, government bonds, corporate bonds, commodities and cash. That spread is deliberate, and means your client's pension is better prepared to withstand sudden market shocks - so when one particular asset class is performing poorly, they shouldn’t be as badly affected. This also adds additional resilience and protection from inflation risk.
Find out more about this from Trevor Greetham, Head of Multi Asset at Royal London Asset Management.
Video Transcript
The performance of different investments can vary wildly from year to year, particularly going into and out of recessions. To get a smoother journey you have to mix different investments and all of the investments we include in the portfolios make sense in the long run.
For example, company shares and commercial property are investments that tend to give you a stake in the real growth in the economy. They've shown very good, long run characteristics of beating inflation across multiple decades.
We have some commodity exposure in the portfolios, just in case of short-term inflation shocks.
We also have government bonds, and government bond returns tend to be a bit of a stabilizer in portfolio's, particularly going into a recession or a slowdown, when the prospect of lower interest rates can mean better returns from bond markets. As we've described, we tailor each portfolio for a specific level of risk appetite, but that isn't the end of the process. That's the start of the process.
Many passive funds just have stocks and bonds, and they will say, about particular levels of risk might be suited to a 50, 50 mix or 60, 40 mix, whatever it might be. Because we've got more asset classes, we tend to ask more questions than just, what is that long run level of risk? We're interested in resilience to shocks. What if inflation rises? What if there's a recession? Can we build in a resilience to those different environments? And we also like to think about the medium-term return expectations for different investments as well. As a good example, a couple of years ago when interest rates were really, really low after the Covid shock was first hitting the economies, government bond yields were really, really low, which meant quite a low prospective return. And we had a very low exposure to government bonds in our portfolios. As bond yields rise, those investments get more interesting as well. So it's about risk, yes, but it's also about resilience.
We also integrate environmental, social and governance (ESG) factors across all the main asset classes within our Governed Range.
Asset classes within our Governed Portfolios
To give an example of the asset classes within our Governed Portfolios, the diagram below shows the split of assets in Governed Portfolio 5 and the breakdown of underlying funds managed by Royal London Asset Management (RLAM).
Source: Royal London, strategic asset allocation breakdown as at 20 April 2023 and equity split breakdown as at 31 March 2023.
Why we invest in certain asset classes
There are three asset classes where we take a slightly different approach to other multi-asset solutions. These being property, commodities and fixed income.
You can learn more about our approach, along with how we integrate ESG factors into these asset classes, by using the drop down boxes below.
Property
Property is a real, tangible asset which we actively manage. Our highly experienced property team understand the lifecycle of property management and includes sector specialists covering retail property, central London offices, industrial property and alternatives.
We have property holdings across many sectors which has helped reduce any liquidity challenges.
The property component of the Governed Range invests in high quality bricks and mortar commercial and industrial properties across the UK, adding real diversification benefits to your clients’ investments. Commercial property is a good inflation hedge as we typically generate rental income above the rate of inflation. This generates capital for us to redevelop properties and increase their value.
ESG integration
ESG integration is also key in determining which properties to buy and sell, as well as minimising any negative impact these have on the local environment and communities through ongoing property management.
Commodities
Rather than owning physical commodities, we use derivative instruments within the Governed Range to track the performance of the underlying commodities with the goal of delivering returns in line with the Bloomberg Commodity Index (industry standard commodity benchmark made up of metals, energy and agriculture).
This approach avoids the high costs of owning, storing, and transporting the physical commodity, but still provides diversification benefits and a hedge against rising inflation.
ESG integration
Although holdings in these commodity futures don’t give investors a vote and can’t directly impact corporate behaviour, RLAM is well placed to influence the environmental, social and governance issues involved in the production and consumption of commodities, primarily through engagement with companies held via our equity allocation and wider involvement in policy advocacy and industry initiatives.
Fixed income
Bonds traditionally perform differently to equities, so we hold a wide range across both companies and governments.
ESG integration
ESG analysis is most applicable to corporate debt, providing RLAM's Global Credit team with an additional perspective on their traditional analysis. They recognise that governance issues may pose the greatest near-term financial risk to companies in high yield markets, while environmental and social issues may have longer-term impacts on returns.
Their rigorous credit research process leads to an overall internal rating score which incorporates nine fundamental factors (e.g. free cash flow, growth prospects, etc). As one of these core factors, ESG issues can move the rating in their internal model up or down. The team works closely with the Responsible Investment team to investigate and understand any significant ESG risks, but the final investment decision lies with the fund manager and takes relative valuation into account.
RLAM’s Sterling Credit team use ESG analysis in the same way as any other form of credit research – to uncover information that credit rating agencies and other market participants might be missing, helping us to make better investment decisions for your clients.
Property
Property is a real, tangible asset which we actively manage. Our highly experienced property team understand the lifecycle of property management and includes sector specialists covering retail property, central London offices, industrial property and alternatives.
We have property holdings across many sectors which has helped reduce any liquidity challenges.
The property component of the Governed Range invests in high quality bricks and mortar commercial and industrial properties across the UK, adding real diversification benefits to your clients’ investments. Commercial property is a good inflation hedge as we typically generate rental income above the rate of inflation. This generates capital for us to redevelop properties and increase their value.
ESG integration
ESG integration is also key in determining which properties to buy and sell, as well as minimising any negative impact these have on the local environment and communities through ongoing property management.
Commodities
Rather than owning physical commodities, we use derivative instruments within the Governed Range to track the performance of the underlying commodities with the goal of delivering returns in line with the Bloomberg Commodity Index (industry standard commodity benchmark made up of metals, energy and agriculture).
This approach avoids the high costs of owning, storing, and transporting the physical commodity, but still provides diversification benefits and a hedge against rising inflation.
ESG integration
Although holdings in these commodity futures don’t give investors a vote and can’t directly impact corporate behaviour, RLAM is well placed to influence the environmental, social and governance issues involved in the production and consumption of commodities, primarily through engagement with companies held via our equity allocation and wider involvement in policy advocacy and industry initiatives.
Fixed income
Bonds traditionally perform differently to equities, so we hold a wide range across both companies and governments.
ESG integration
ESG analysis is most applicable to corporate debt, providing RLAM's Global Credit team with an additional perspective on their traditional analysis. They recognise that governance issues may pose the greatest near-term financial risk to companies in high yield markets, while environmental and social issues may have longer-term impacts on returns.
Their rigorous credit research process leads to an overall internal rating score which incorporates nine fundamental factors (e.g. free cash flow, growth prospects, etc). As one of these core factors, ESG issues can move the rating in their internal model up or down. The team works closely with the Responsible Investment team to investigate and understand any significant ESG risks, but the final investment decision lies with the fund manager and takes relative valuation into account.
RLAM’s Sterling Credit team use ESG analysis in the same way as any other form of credit research – to uncover information that credit rating agencies and other market participants might be missing, helping us to make better investment decisions for your clients.
Equities
The equity exposure within the Governed Range covers UK, developed overseas and emerging markets. Each region consists of different companies which operate in different sectors, offering a diverse growth asset.
Our customers are, in effect, shareholders in a wide range of companies around the world, with every major industry represented. This means they have a say in how these companies are managed and how they impact the world around them.
Equity exposure within our Governed Portfolios is gained through the RLP Global Managed Fund. The RLP Global Managed Fund provides a well-diversified solution, which allows customers to gain exposure to global equity markets.
ESG integration
The integration of ESG differs for active and passive strategies:
- Active equity fund
Around 30% of the equity component is invested in actively managed equity funds with fund managers leveraging ESG insights to inform their decision-making process. - Tilted equity funds
In 2021, RLAM transitioned its passive equity funds from index trackers to ESG
and climate ‘tilted’ funds. RLAM’s updated investment process continues to deliver a risk and return profile similar to the index, but it now incorporates ESG and climate-related investment criteria, and introduced the ability to ‘tilt’ the funds towards or against these factors.The funds’ new objectives are to reduce carbon intensity and improve their ESG and responsible investment profile, in addition to providing low risk returns relative to benchmark.
We believe that by incorporating ESG factors in the investment decisions process, we can deliver better outcomes for our customers - both financially, and for the wider environment.
In addition to reducing the carbon intensity of our investments, our more active management approach will give us the flexibility to adjust our exposure to companies with poor social practices or corporate governance issues.
- Emerging Markets ESG Leader Tracker fund
This fund accounts for around 10% of the equity component (just over £3bn) and tracks an ESG benchmark made up of companies that have the highest environmental, social and governance (ESG) performance in each sector of the wider MSCI Emerging Markets Index. There can be lower standards of behaviour and governance in some countries included in this index, so we believe a hard screening approach is more appropriate.