ii ACE 40 rated list: two removals and one new entrant

A torrid year to date for ESG prompts Morningstar to act.

• Removed: Syncona Investment Trust 
• Removed: abrdn Europe ex UK Ethical Equity
• Added: M&G European Sustain Paris Aligned

Funds and investment trusts in the sustainable space have grown in popularity among investors in recent years with some strong performance, boosted by their bias to growth-oriented sectors.

More recently the tables have turned, for now at least. So-called value stocks have returned to favour, with sustainable stocks falling behind, although it’s been a tough time for markets across the board.

Over the year to date to end May 2022, only two ii ACE 40 sustainable rated funds delivered positive returns, and these were in niche sectors that have been better insulated from recent market storms. VT Gravis Clean Energy Income Fund is up 6.1% over the year to date, and iShares Global Clean Energy ETF (LSE:INRG) is up 1.3%, according to Morningstar.

In comparison, 24% of ii’s Super 60 rated list have delivered positive returns over the extremely challenging year to date (16 out of 66).

Long-term performance of ACE 40 is strong: over three years 60% of funds are in 1st and 2nd quartile relative their peers (both sustainable and conventional strategies) and over five years, almost 80% outperformed their benchmarks. Over five years only one fund lost money - Lyxor Green Bond (LSE:CLIM) ETF.

The challenges particularly facing sustainable funds over the year to date prompted Morningstar’s Manager Selection Services Group to take a closer look at ii’s ACE 40 rated list outside of the annual review period, which is due in quarter 4.

Morningstar Manager Selection Services Group took over the day care of ii’s rated lists in January 2022, working to ii’s methodology, and overseen by ii’s Head of Fund Research, Dzmitry Lipski.

To be or not to be?

While there are only two removals from ACE 40, Syncona (LSE:SYNC) Investment Trust and abrdn Europe ex UK Ethical Equity, they do illustrate Morningstar’s clear independence. The removal of Syncona comes just eight months since ii decided to retain Syncona after a formal review of the risks.

Removal – Syncona Investment Trust

Dzmitry Lipski, Head of Funds Research, interactive investor, says: “We have always categorised Syncona as an adventurous choice on ACE 40. Standing on a relatively high premium when it made its debut at the launch of our ethical rated list in late 2019, we were comforted by the trust’s unique proposition, social purpose and strong management team. 

“Conviction was tested after poor performance and premium/ discount volatility led to a formal review of the risks last summer, and we decided to retain the trust in October 2021. While the performance since has been less volatile, we are also mindful that the outlook forbiotech companies is more challenging than it has been, even for a conservatively managed company like Syncona. We respect Morningstar’s independence.

“We continuously review the list to ensure it meet customer needs and, in this instance, given the significant shift in the market environment this year we agreed with Morningstar to make these changes. We understand that some funds with an ethical/ESG overlay have a relatively restricted investment universe, leading to portfolio biases, or a style that could have an impact on portfolio performance.”

Morningstar says: “We feel that the level of risk the trust displays is elevated relative to the benefits. Given the niche nature of the trust it makes it hard to discern if the team and structure are the best available options to access this area of the market. Investor returns are also heavily reliant on sentiment rather than NAV performance, with big swings in both the premium and discount in recent times. The risk in the underlying investments is also significant, with a highly concentrated portfolio of companies involved in an area where outcomes of clinical trials can swing performance heavily one way or another. It is our recommendation that the trust be removed from the ACE 40 fund list.”

Removal: abrdn Europe ex UK Ethical Equity

Morningstar says: “Compared to peers, the team’s fund management experience remains limited. The fund has typically displayed a growth style bias and a market cap that is slightly lower than that of peers and the index. Despite the fund's growth style, which should have until recently been a tailwind to performance, performance over their tenure has been lacklustre with the fund only managing to deliver strong relative outperformance in 2020. Overall, we believe that there are stronger fund options available in this sector and have therefore recommended the removal of this fund from the ACE 40 fund list.”

Addition:M&G European Sustain Paris Aligned

Morningstar says: “John William Olsen took over this strategy in July 2014, having joined M&G earlier that year from Danske Capital, where he had built strong track records on global and European strategies. In addition to this strategy, Olsen manages the Global and Positive Impact strategies, but has deputy manager, Mike Oliveros, for support on this strategy.

“Olsen employs broadly the same process here as he did at Danske, which is to focus on finding companies with sustainable competitive advantages that should lead to pricing power and superior returns over the long term, and then wait for an opportunity to buy them at attractive valuations. In 2021, the process was adapted to include carbon research.

“The aim of this is to help identify companies which have a meaningful plan to reduce their carbon emissions using science-based targets, and thus aligning the portfolio to the Paris agreement to limit temperature rises to 1.5 degrees.

“Furthermore, there is the requirement for the portfolio to have a weighted carbon intensity at least 50% lower than the benchmark. The portfolio is typically concentrated in 25-35 stocks with investments broadly split into “stable growth” (companies with a large competitive advantage) and “opportunities” (narrower competitive advantage) stocks, but this is a sliding scale of quality/valuation rather than a barbell. Opportunities stocks have more operational risk but greater potential upside, and the manager requires a larger margin of safety on the valuation for such stocks. With its re-focus on carbon, there are now some additional exclusions, such as gambling and weapons.

“Performance over Olsen's tenure has been strong and given M&G European Sustain Paris Aligned fund's quality characteristics, we broadly expect the fund to hold up better than peers in falling markets but potentially lag in strongly rising markets. Additionally, the concentrated nature of the portfolio may at times mean that the fund's return profile is more volatile than that of peers.”