M&G Investments: M&G SMA Celebrating 3 years of sustainable multi-asset investing

Author: Maria Municchi

The value and income from a fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance.

• The M&G Sustainable Multi Asset range was launched in December 2020 with the intention of flexibly investing in listed global assets that seek to address some of the world’s greatest environmental and social challenges, while delivering competitive financial returns for our clients.
• The funds have successfully navigated a tumultuous period for global financial markets by running well-diversified, actively managed portfolios with sustainability at their core. With interest rate policy normalising, we think the prospects for a more balanced market environment driven by a restoration of traditional equity/bond correlations are increasing.
• In this note, we outline why we think our suite of three volatility-managed^[1] funds (M&G Sustainable Multi Asset Cautious, M&G Sustainable Multi Asset Balanced and M&G Sustainable Multi Asset Growth) could be a compelling choice for the sustainability-minded multi-asset investor in 2024.

The shifting global investment landscape

Over the three years since the funds were launched, the world has faced a multitude of challenges, including the fallout from a global pandemic, wars in Europe and the Middle East, the fastest interest rate tightening cycle in decades, and ballooning fiscal deficits. Alongside this, we appear to be on the precipice of a new economic paradigm with issues such as geopolitics and climate change at the forefront of investors’ minds.

The rapid interest rate hiking cycle, and subsequential higher cash rates have challenged the role of a balanced multi-asset portfolio seeking returns through income and capital appreciation. However, as the chart below demonstrates, we would argue that prospective returns in the multi-asset space now look highly attractive at current yields, in our opinion, particularly when you consider that a large portion of developed market government debt offered negative yields only a few years ago. Multi-asset portfolios now seem better equipped to provide investors with a solid foundation in terms of risk/return opportunity.

Figure 1. Prospective returns for multi-asset portfolios look attractive at current levels of yield

M&G, Refinitiv Eikon, December 2023. Past performance is not a guide to future performance

Combining global asset allocation with sustainable investing

Drawing on their sustainable investment universe, the funds in the M&G Sustainable Multi Asset range flexibly allocate capital across a variety of global asset classes seeking to generate attractive risk-adjusted returns. The absence of benchmark constraints means we have the flexibility to invest across asset types, geographies and sectors, creating diversified and distinctive portfolios.

Our preference for using direct holdings in the funds means we can take a much more considered view on individual investment cases and ESG quality. We are better able to engage with companies to enhance long-term shareholder value and encourage the adoption of sustainability objectives, such as science-based targets around greenhouse gas emissions, for example. Investing directly also allows us to take a very granular approach to reporting, detailing what exactly we hold and why, and what the company Key Performance Indicators are that we monitor in relation to sustainability. We regularly consult sector analysts in our equity and fixed income teams for their views, and their analysis feeds into our impact investment framework for all positive impact holdings.

Crucially, the funds can access a growing pool of sustainability-linked investments, including listed green infrastructure assets and increasingly popular ESG-related financing solutions, such as supranational bonds and green bonds. This has enabled the funds to increase their allocation to investments identified using M&G’s Positive Impact Framework. These holdings are often long-term in nature and aim to generate a positive social and/or environmental impact, alongside a financial return. Assets in this space are increasingly providing a valuable source of investment ideas, often connected to green industries or positive social activities, and many have acted as a useful diversifier among difficult market environments. For example, renewable energy infrastructure assets were a useful component in the portfolios during the bond and equity market volatility of 2022.

We strive to be fully transparent about the impact cases supporting our holdings and the sustainability achievements within the funds. In order to do this we publish an annual ESG and Impact Report for each fund that are available on our website.^[2]

Figure 2 illustrates the breadth of current fund holdings across both the positive impact and ESG/sustainable investment spectrum. Each fund is currently allocating over 40% of assets towards impact investments (the green shaded boxes below), with a minimum holding of 20%.

Figure 2: Combining asset allocation and sustainability

Source: M&G, 30 November 2023. Portfolio shown is M&G Sustainable Multi Asset Balanced Fund, for illustrative purposes only.

We believe that active management, and in particular dynamic tactical asset allocation which is a core part of our investment process, is essential to adapt to the rapidly changing market conditions that we currently find ourselves in, while a diversified portfolio is essential in an environment of such uncertainty. Figure 3 illustrates the highly flexible and active nature of the portfolios since inception.

Figure 3: Active asset allocation across asset classes

Source: M&G, 30 November 2023. Portfolio shown is M&G Sustainable Multi Asset Balanced Fund, for illustrative purposes only.

While the last three years have presented several challenges, the funds’ approach to asset selection combining strategic decision-making and tactical short-term opportunities has remained front and centre of our approach, enabling the funds to use their full range of capabilities in order to take advantage of exciting investment opportunities, some of which we describe in more detail below.

Three years, three key trades

2021: Tactically responding to weak price action: In October 2021 we shifted the equity composition of the funds to take advantage of short-term price moves in the tech and healthcare equity sectors, both of which had recently underperformed on a relative basis despite underlying strength in the investment cases. We decided to add to some of the largest underperformers in the portfolio to broaden our equity exposure, especially in positions where we felt the earnings story remained solid. The market subsequently rallied and within a month we sold back some of the exposure to unwind the trade, bringing the equity allocation back down to a more ‘neutral’ position across the funds.

2022: Keeping a cool head among gilt market panic: The UK’s “mini budget” spending announcement triggered a dramatic gilt market sell-off in September 2022. 30-year gilt yields soared in just a few days as investors became swept up with fear over the prospect of unfunded tax cuts and possible repercussions for the UK’s public finances. In our view, the speed of the market moves and the sole focus on the fiscal package itself, disregarding the lack of a strong historic relationship between UK balance sheet health and gilt yields created an interesting tactical opportunity. We decided to purchase positions in longer-dated gilts. The 30-year yield eventually reached 5% until the Bank of England (BoE) intervened to buy long-dated gilts. This backstop had a dramatic calming effect, and yields rapidly fell back below 4%. In light of the BoE’s action, the team decided to close the tactical position profitably on 3 October. We continued to express asset allocation views in the funds via positions in gilts (including green gilts) in 2023, particularly as we broadened our duration exposure in the face of slowing UK economic data and attractive bond valuations.

2023: Tactically reducing Japanese equities, locking in profits: The strength of the rally in Japanese equities over the first half of 2023 meant that the asset class was a leading contributor to returns in the funds over this period (on a local currency basis). However, by mid-summer, this good performance had left equity valuations notably less attractive at the index level relative to other markets. The funds’ Japanese equity holdings were still trading at a reasonable 13x P/E by June 2023, but this was notably higher than the 10x P/E levels they had started the year at, removing some of their appeal versus peers in Europe and the UK. Even though the decision to reduce our exposure to such strongly performing assets felt difficult at the time, we maintained our valuation discipline and removed our overweight exposure to the country across the funds.

The case for sustainable investing

Despite the altered environment that we face in terms of structurally higher rates and inflation, we believe that our investments stand to benefit from significant long-term structural drivers. For example, while the outbreak of war in Ukraine sparked a period of underperformance for sustainability-linked assets in 2022, these events have brought into sharp focus the importance of sustainable investing, particularly around energy independence. Many countries are striving to improve their energy security and diversify energy sources, putting renewable power and green energy technology firmly on the agenda of many governments and global companies. Also, recent government initiatives such as Repower EU in Europe and the Inflation Reduction Act in the US is directing billions of dollars of support towards the energy transition. The graphic below highlights more sustainability drivers that we think are helping to create long-term investment opportunities for sustainably-focused assets. 

The rapid increase in the policy rates in response to rampant inflation also put ‘sustainable’ industries under intense pressure given their perceived growth factor bias. However, with many assets now trading on attractive valuations, we think the recent dip in performance could present an excellent opportunity for investors to access the compelling long-term structural growth story linked to sustainably-focused investments, potentially providing investors with a good source of returns from here. This includes listed energy infrastructure assets (a core element of the portfolio as well as a key diversifier) which are now trading at significant discounts to NAV. As well as being clear beneficiaries of the green energy transition, these holdings offer stable and resilient income streams, potentially valuable characteristics in a world of higher structural inflation. 

Figure 4: Sustainability drivers and themes 

Source : M&G

Despite the altered environment that we face in terms of structurally higher rates and inflation, we should reiterate that we are long-term investors with a portfolio of assets which should stand to benefit from the long-term structural drivers listed above. As long-term investors, our focus is on the ability of our holdings to generate value for society and our investors over the long run. Furthermore, our portfolio of positive impact assets should continue to deliver compounding positive impacts to society as well as looking to provide financial returns.

As at 30 November 2023, each fund’s MSCI ESG score – reflecting the average ESG rating of corporate holdings as shown by MSCI’s ESG classification – was above 7 for all funds (equivalent to an MSCI ESG rating of AA). Each fund’s corporate holdings currently have a significantly lower carbon intensity (a measure of a company’s carbon emissions produced in relation to its sales) than the global equity market (MSCI World), a reflection of the climate focus running throughout the portfolios. All funds in the range are rated 6 by MSCI for their MSCI ESG government bond ratings (scores range from 0-10).

As we’ve highlighted above, the fund range continues to allocate significant exposure to positive impact investments, targeting companies that aim to actively address some of today’s big environmental and social challenges. We also hold positions dedicated to infrastructure, notably in selected companies focused on renewable energy strategies, as well as other impact assets such as green bonds where proceeds are specifically directed towards projects with sustainable objectives. 

Past performance is not a guide to future performance.

Source: Morningstar, Inc and M&G, as at 31 December 2023. Returns are calculated on a price-to-price basis with income reinvested. Benchmark returns stated in GBP terms.

The fund’s respective benchmark is a comparator against which the fund’s financial performance can be measured. The sector has been chosen as the benchmark as it reflects the financial aspects of the fund’s investment policy. The benchmark does not constrain the fund's portfolio construction. The fund is actively managed. The fund manager has complete freedom in choosing which investments to buy, hold and sell in the fund within the constraints set by the fund’s objective and investment policy.

The main risks associated with the funds:

• Investments in bonds are affected by interest rates, inflation and credit ratings. It is possible that bond issuers will not pay interest or return the capital. All of these events can reduce the value of bonds held by the fund.
• The fund is exposed to different currencies. Derivatives are used to minimise, but may not always eliminate, the impact of movements in currency exchange rates.
• Investing in emerging markets involves a greater risk of loss due to greater political, tax, economic, foreign exchange, liquidity and regulatory risks, among other factors. There may be difficulties in buying, selling, safekeeping or valuing investments in such countries.
• The fund may use derivatives to profit from an expected rise or fall in the value of an asset. Should the asset’s value vary in an unexpected way, the fund will incur a loss. The fund’s use of derivatives may be extensive and exceed the value of its assets (leverage). This has the effect of magnifying the size of losses and gains, resulting in greater fluctuations in the value of the fund.
• In exceptional circumstances where assets cannot be fairly valued, or have to be sold at a large discount to raise cash, we may temporarily suspend the fund in the best interest of all investors.

[1] The Cautious, Balanced and Growth funds have respective ex-post volatility ceilings of 9%, 12% and 17% per annum, measured over rolling five-year periods. Although the funds have been managed with these levels in mind since launch, we won’t be able to comment on the fulfilment of this risk objective until the funds have five years of investment return history. 

[2] https://www.mandg.com/investments/professional-investor/en-gb/literature?t=literature-categories%2Fesg-process

[3] Sustainability drivers and themes support the company case studies we have highlighted in each fund’s latest ESG and Impact Report, available on our website: https://www.mandg.com/investments/professional-investor/en-gb/literature?t=literature-categories%2Fesg-process