Our approach to diversification
Designed to strengthen resilience and target opportunities across a wide range of asset classes.
We believe that investing in a wide range of asset classes helps deliver more consistent performance whatever is happening in the economy and markets. In turn, this can help deliver better outcomes for your clients.
The Governed Range portfolios (the Governed Portfolios and Governed Retirement Income Portfolios) hold a broad mix of assets, including equities, government and corporate bonds, property, commodities and cash-type investments. This spread is deliberate - to help the portfolios better withstand sudden market shocks. It also adds additional resilience and gives some protection against 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 portfolios, 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.
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.
Source: Royal London, strategic asset allocation breakdown as at 30 June 2024 and equity split breakdown as at 31 May 2024.
Why we invest in certain asset classes
There are three asset classes where we take a slightly different approach to other multi asset solutions - property, commodities and fixed income.
You can learn more about our approach, as well as how we integrate environmental, social and governance (ESG) factors into these assets classes, below.
Property
Property is a real, tangible asset which is actively managed within the Governed Range portfolios. Royal London Asset Management's experienced property team understands the lifecycle of property management and includes specialists covering retail property, central London offices, industrial property and alternatives.
Royal London Asset Management has property holdings across many sectors, which helps reduce any liquidity challenges.
The property component of the Governed Range portfolios invests in high-quality bricks and mortar commercial and industrial properties across the UK. Commercial property is a good inflation hedge, typically generating rental income above the rate of inflation. In turn, this generates capital for Royal London Asset Management 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 the Governed Range portfolios hold a wide range across both companies and governments.
ESG integration
ESG analysis is most applicable to corporate debt, providing the Royal London Asset Management credit team with an additional perspective on its traditional analysis. The team recognises that governance issues may pose the greatest near-term financial risk to companies in high yield markets, which environmental and social issues may have longer-term impacts on returns.
Its rigorous credit research process leads to an overall internal rating score which incorporates nine fundamental factors, including free cash flow and growth prospects. As one of these core factors, ESG issues can move the rating in the team's 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.
Property
Property is a real, tangible asset which is actively managed within the Governed Range portfolios. Royal London Asset Management's experienced property team understands the lifecycle of property management and includes specialists covering retail property, central London offices, industrial property and alternatives.
Royal London Asset Management has property holdings across many sectors, which helps reduce any liquidity challenges.
The property component of the Governed Range portfolios invests in high-quality bricks and mortar commercial and industrial properties across the UK. Commercial property is a good inflation hedge, typically generating rental income above the rate of inflation. In turn, this generates capital for Royal London Asset Management 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 the Governed Range portfolios hold a wide range across both companies and governments.
ESG integration
ESG analysis is most applicable to corporate debt, providing the Royal London Asset Management credit team with an additional perspective on its traditional analysis. The team recognises that governance issues may pose the greatest near-term financial risk to companies in high yield markets, which environmental and social issues may have longer-term impacts on returns.
Its rigorous credit research process leads to an overall internal rating score which incorporates nine fundamental factors, including free cash flow and growth prospects. As one of these core factors, ESG issues can move the rating in the team's 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.
Equities
The equity exposure within the Governed Range portfolios is through the RLP Global Managed Fund, which covers global equity markets including the UK, developed overseas markets and emerging markets. Within each region, there are different companies operating in different sectors, with every major industry represented. This means there's a very high level of diversification.
ESG integration
The integration of ESG differs for active and passive strategies:
- Active equity fund
Around 30% of the exposure in the RLP Global Managed Fund is invested in actively managed equity funds, with fund managers using ESG insights to inform their decision-making process.
- Tilted equity funds
In 2021, Royal London Asset Management transitioned from passive index-tracking equity funds to tilted funds which incorporate ESG and climate-related criteria in the investment process. Holdings are adjusted (tilted) to be deliberately overweight or underweight in selected assets to help the funds meet their objectives.
The tilted funds' current objectives are to reduce carbon intensity and improve the ESG and responsible investment profile, in addition to delivering low-risk returns relative to the benchmark.
We and Royal London Asset Management believe that incorporating ESG factors in the investment decision-making process can help deliver better outcomes for customers - both financially and for the world they live in.
In addition to reducing the carbon intensity of investments, this more active management approach gives the flexibility to adjust 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 of the Governed Range portfolios (over £3 billion) and tracks an ESG benchmark made up of companies that have the highest environmental, social and governance 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.