Sustainability Issue 1: Q1

SUSTAINABILITY

Sustainable investing at RLAM Issue 1: Q1 2019 FOR PROFESSIONAL CLIENTS ONLY, NOT SUITABLE FOR RETAIL INVESTORS.

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Welcome Sustainable investing is based on a simple premise. That is, owners and managers of capital, whether that is equity or debt, can positively influence society by prioritising investment in those companies that are helping move to a cleaner, healthier, more inclusive society.

Mike Fox Head of Sustainable Investments

Sustainable investing is also based on the belief that by prioritising investment in those companies doing this, either through the products and services they produce, or by effective management of the environmental, social and governance (ESG) issues they face, superior longterm investment returns can be achieved.

Done well, sustainable investing has the potential to improve the society we live in and deliver excellent investment returns.

The question is why this style of investing is not as widely implemented by investors as it could be. There does, to some extent, remain a bias that embedding what would be considered to be a non-financial goal, to improve the society we live in, will have a negative impact on investment performance. This may have been true at some point in the past, but there is ample evidence to suggest this is not the case now.

In recent years we have seen investors place an increasing value on those companies providing solutions to some of the biggest societal issues of the day.

Whether this is the reduction of carbon emissions through moving to cloud computing or renewable energy, or the improvement of healthcare through better diagnosis and treatment of disease, companies providing genuine solutions tend to have stronger prospects. Equally

those companies not managing their ESG issues properly expose investors to unnecessary risks, particularly as corporate behaviour is under more scrutiny than ever before.

This increased confidence in the ability of sustainable investing to deliver strong investment returns is happening at a time when most consumers are looking beyond the basic utility of the products they buy, to wanting to understand the environmental and social context in which these products are made. We have seen this with the rise of organic and fresh produce within supermarkets, and concerns about the impact plastic is having on the environment. It is an entirely natural progression of this trend that consumers are starting to question how their savings are being invested, and the social and environmental consequences of their investment decisions. Sustainable funds are a great way for investors to save in a positive way. Equally, there is an increase in the regulatory requirement, particularly in the pensions market, to embed Sustainability considerations.

Overall, we think we are still in the early stages of the rise of sustainable investing, with it being increasingly accepted as a style of investing capable of delivering strong investment returns and benefiting society as a whole.

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Our investment approach – an interview with Victoria McArdle Sustainable Investment Analyst

Q W hat is your role?

A It is my role to identify potential investment opportunities for the sustainable funds and then undertake detailed analysis to understand if they are suitable for investment.

Q How do you identify potential investment opportunities?

A One way of describing our approach to sustainable investing is to support the transition to a cleaner, safer, healthier and more inclusive society. This framework gives me clear direction as to the kind of companies to look for.

Q Do you use investment themes?

A Our approach isn’t dogmatically thematic as we won’t buy

into any investment unless we see the potential for good returns. For example, we wouldn’t have our ‘Next Generation Medicine’ theme in the portfolio if we didn’t think the companies within it offered good value. That said, investing in this way often has a strong thematic element to it and when looked at overall our portfolios have a strong thematic element to them.

Q W hat does the investment analysis process involve?

A Like most investors, our approach will involve looking at

the business strategy, financial statements and valuation of a company. Unlike most investors however, we will also look at the societal benefits of the products and services provide by a company and their environmental, social and governance (ESG) standards. We believe a true understanding of a company and its investment prospects can only be gained by this two track approach: financial and products services/ESG.

Q W hy do you think your approach is effective in identifying investment ideas?

A Companies with socially useful products and services tend to

be more innovative, higher growth, and less cyclical than the average company. Also those companies with strong ESG standards tend to be lower risk, as bad ESG usually manifests itself in poor company performance over time. As such, companies we invest in arguably have better growth prospects with lower risk.

Q W hich area of the funds are you currently most excited about?

A Of particular interest at the moment is the ability to use data, extracted from the physical world via sensors, to improve the efficiency, and therefore environmental performance, of a number of industries such as agriculture and construction.

This theme comes under the heading ‘Industry 4.0’.

How we extract and use data is still very much in its early stages of development and we are excited about this area going forward.

Q Could you give an example of a company that fits into this theme?

A Trimble is a company which delivers products and

services that connect the physical and digital worlds. Core technologies in positioning, modelling, connectivity and data analytics enable customers to improve productivity, quality, safety, and sustainability. Applying Trimble’s services to agriculture, for example, can increase crop yields by up to 30%, reduce input costs and water usage by 20%, thereby lowering the environmental impact of this industry by reducing carbon emissions and reducing waste.

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Our current equity themes Themes can and do change overtime.

We think it’s important to have the flexibility to evolve as society evolves too, ensuring that at all times we are investing in the most relevant themes and the ones most likely to deliver strong investment returns. Our current themes include:

Industry 4.0 Steam was industry 1.0, electricity 2.0, and the computer 3.0. Industry 4.0 is data and using it to bring together the physical and digital worlds to enhance the efficiency of a range of existing industries.

Agriculture and naturalness Demands on food production will continue to grow as demand for protein is linked to rising wealth, particularly in developing countries. The current system, based on the use of chemicals to enhance production, needs to be changed for smarter, more natural methods of food production.

Artificial intelligence and cloud computing The exponential growth in the amount of data in existence, and in computing power, is allowing data to be used to make better decisions in areas such as healthcare diagnosis and energy usage.

Electric/autonomous vehicles Transportation remains one of the major sources of pollution due to the use of combustion engines. Cars are also the source of many deaths and injuries.

Electric and autonomous vehicles offer the opportunity to move transportation into a cleaner, safer future.

Next generation medicine The current healthcare system is based on diagnosis methods and drug treatments that are slow and often ineffective. The ability to extract more accurate and timely health information

from our bodies, and the ability to obtain our individual genetic profile, offer the opportunity to significantly enhance the standard of healthcare.

Social infrastructure Areas such as water and electricity still require significant investment in the future for developing countries to be fully connected and also improve the way they are delivered in developed countries.

Other areas such as social housing are relevant to this theme too.

Energy transition The way we have historically extracted energy from the sun is via fossil fuels. Renewable energy, such as solar, offers the opportunity to extract energy directly from the sun in a cleaner more sustainable manner.

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Global greenhouse gas emissions by economic sector

Electricity and heat production

25%

Agriculture, forestry 24% and other land use 6%

Buildings Transportation

14%

Industry

21%

Other energy

10%

Source: IPCC (2014); based on global emissions from 2010.

Electric and autonomous transportation Theme background Transportation is the fourth largest source of greenhouse gas emissions.

Rightly, this has come under scrutiny from governments wishing to meet their obligations to reduce the impact of climate change and global warming. Equally as important is the number of deaths attributed to transportation, estimated to be 1.3m each year by the World Health Organisation. The message is clear: transportation is both polluting and dangerous, and must change.

Fortunately, credible solutions are at hand. The more energy production comes from renewable energy, the more sense it makes to remove combustion engines from transportation, in favour of electric power.

Equally, technological breakthroughs have made machine vision more accurate than human vision. This is the basis for

autonomous vehicles. Computers don’t get distracted or drink and drive, and have a much lower error rate than humans.

Investing in this theme supports the transition to cleaner, safer, more sustainable transportation. In this endeavour, we have identified a number of companies whose products and services will see a material benefit from this transition.

Companies benefiting from the move to electric and autonomous transportation Aptiv

Aptiv is a technology company that delivers the software capabilities, advanced computing platforms and networking architecture that will facilitate the future of mobility: electric and autonomous vehicles. It aims to make them safer, greener and more connected.

Infineon

Infineon is a Germany designer, developer and manufacturer of semiconductors.

It provides a range of products that can be used by customers to increase their product’s energy efficiency. Infineon is the second largest supplier to the automotive industry, providing microcontrollers to reduce vehicles’ energy consumption and emissions.

TE Connectivity

TE Connectivity designs and manufactures connectivity and sensor solutions for a variety of industries including automotive.

As transportation becomes electrified and autonomous, the needs for sensors, to detect objects, and connectivity, to transfer data and power, increases.

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Sustainable fixed income Sustainable fixed income has evolved quite rapidly of late. As managers of equity and fixed income sustainable funds RLAM believe that environmental, social and governance (ESG) issues are vital in all credit research.

As such, we combine rigorous financial analysis with assessments of how ESG factors could influence the risk profile of the issuers. We have to judge whether the overall risk profile, based on financial and ESG factors, is appropriately reflected in the valuation of a bond. We combine this analysis with a number of other features, in particular a bias towards secured debt or bonds with strong covenant protections and an emphasis on portfolio diversification. Overall, our approach allows us, as active managers, to take advantage of credit market inefficiencies arising from over reliance on credit ratings and benchmark composition.

The sustainable funds which contain fixed income use the above approach and apply further criteria, to give preference to issuers where the provision of debt financing will support the move toward a more sustainable society. Like with equities, this can be through supporting entities with socially and environmentally useful products and services, or those with strong ESG management. To this end we include four themes which we believe benefit society: • Community: covering education, health and social care • Housing: with a focus on social and affordable housing • Utilities & Environment • Infrastructure These themes focus on those areas where we believe there is a clear benefit to society and also a clear long term investment case. This means that we will look for opportunities in a wide range of areas. For example, social & affordable housing, hospitals, transport, roads, schools & universities, water infrastructure, electricity distribution and telecommunication. We will aim to have at least half of the Fund’s bond holding in securities linked to one of these themes, subject to sufficient portfolio diversification being achieved.

Engagement Engagement with companies on strategic, governance, and environmental and social risk management issues forms a core part of our stewardship responsibilities. It is an activity that many of our clients have come to expect from us as a long-term asset manager. Engagement may also help us select and monitor companies in our sustainable funds.

The purpose of engagement will be driven by one or more of the following criteria: • To support the investment decision-making process • To address real or perceived risks to companies • For information-gathering purposes, i.e. to better understand a company or sector • To apply pressure for change to a company policy or practice; or to help companies build a case for change internally • To voice concerns about a policy or practice on behalf of RLAM or its clients Examples of engagement we have carried out in the last year include: • Unilever – we engaged on the proposed single listing structure which would have seen the company removed from UK indices such as the FTSE-100. We also engaged remuneration and plastics/packaging.

• Amazon – we engaged on corporate governance with respect to the joint chairman/Chief Executive role and responsible tax in collaboration with other investors.

• Severn Trent – we engaged on executive pay with the result that the company changed its approach.

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Our fund range Our funds are designed to work both as single funds and as a suite. We range from 100% fixed income to 100% equity, with three mixed asset funds grading upwards in between.

The aim is to ensure that whatever your risk profile, income or capital requirements there will be a fund to match your requirements, all within the same RLAM sustainable investment process.

We also offer a segregated, bespoke, service for institutional clients with their own requirements. We can tailor asset allocation, with both equities and fixed income, either UK or Global, and embed sustainability criteria to match exact specifications.

UK equities Overseas equities Fixed income

Managed Growth IA Mixed Investment 0%-35% Shares Sector Managed Income IA Sterling Corporate Bond

Diversified IA Mixed 20%-60% Shares Sector

World IA Mixed Investment 40-85% Shares Sector

Leaders IA UK All Companies Sector

Fixed income

Equity

Sector rankings

1 year

3 years

5 years

Fund size

Sustainable Managed Income Sterling Corporate Bond

12/93

24/86

18/80

£40.1m

Sustainable Managed Growth Mixed Investment 0-35% Shares

4/54

2/50

1/40

£203.6m

Sustainable Diversified Mixed Investment 20-65% Shares

14/148

2/140

1/119

£611.8m

Sustainable World Mixed Investment 40-85% Shares

15/157

2/146

1/121

£560.8m

Sustainable Leaders UK All Companies

8/262

23/249

12/237

£569.6m

For illustrative purposes – reflects approximate percentage asset allocation, weightings may vary. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.

Source: RLAM and FE as at 31 December 2018. All Fund Performance shown is based on the C Acc share class, which is the clean share launched post RDR except for Sustainable Diversified Trust which is C Inc share class.

Further information www.rlam.co.uk Webinars and videos Stewardship Statement Sustainable fund pages

Contact us

For further information about our sustainable investment capabilities, please contact us.

Royal London Asset Management 55 Gracechurch Street London EC3V 0RL 020 7506 6500 institutional@rlam.co.uk bdsupport@rlam.co.uk The views expressed are the author’s own and do not constitute investment advice.

All information is correct at January 2019 unless otherwise stated.

Issued by Royal London Asset Management Limited, Firm Registration Number: 141665, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, Firm Registration Number: 144037, registered in England and Wales number 2372439; RLUM Limited, Firm Registration Number: 144032, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between subfunds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland.

All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office: 55 Gracechurch Street, London EC3V 0RL. The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal London Mutual Insurance Society Limited is on the Financial Services Register, registration number 117672. Registered in England and Wales number 99064.

Ref: N RLAM PD 0012

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