BNY Mellon Sustainable Real Return: November 2023 fund Update

• The experienced Real Return team implement their time-tested strategy on this fund, but with added emphasis on sustainability
• They're one of the best-resourced teams in the sector
• We think the fund could be a good consideration for a conservative portfolio, or bring diversification to a more adventurous one
• This fund is on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The BNY Mellon Sustainable Real Return fund aims to reduce volatility by providing some shelter during market wobbles, while also delivering some long-term growth in a sustainable way, by investing in companies that comply with their in-house environmental, social and governance (ESG) criteria. This means it could be a good option for a more defensive portfolio seeking steadier gains, and those who wish to invest in Responsible funds. It could also be a useful addition to more adventurous portfolios focused on company shares, by giving exposure to other asset classes and adding some balance.

Manager

Matthew Brown and Philip Shucksmith have managed the fund since launch in April 2018. They're both experienced investors and have served on the Real Return team for well over a decade.

BNY Mellon's team-based investment process, however, is built on the principle that the whole is greater than the sum of its parts. The fund is managed with an investment approach that is heavily reliant upon the skills and experience of the wider Real Return investment team.

The team's built up a good track record over a long period of time with the BNY Mellon Real Return Fund, which has featured on the Wealth Shortlist (and formerly the Wealth 50 and 150) since December 2010. The team's experience and time-tested investment process gives us confidence they can deliver good returns in a sustainable way with this fund, although there are no guarantees.

Process

The team aims to make money in a variety of market conditions. They do this using a mix of assets that broadly fall into two camps. The first is called the 'return-seeking core'. It invests in assets the team think will provide long-term growth, such as shares and bonds issued by well-run, financially secure companies with a unique set of advantages over the competition. They also consider how well those companies manage their impact on the environment and society.

The rest of the fund is called the 'stabilising layer' and invests in government bonds, commodities and cash, with the aim of adding stability to returns. The managers alter the amount invested in each section of the fund depending on their view of the world. The managers also use derivatives within the ‘stabilising layer’ which adds risk.

The team places more emphasis on not losing money than making it. If you lose less money in the bad times, you have less ground to make up in the good times. They use diversification, hedging (investing to potentially benefit in a range of outcomes), and liquidity (investing in things that are easy to buy and sell) to help achieve this, as well as derivatives. The team also has the flexibility to invest in high-yield bonds and emerging markets which, if used, adds further risk.

While the team tries not to lose money, the assets they invest in can go down in value. They measure their performance over the long-term (which is considered to be five years or longer) against SONIA (Sterling Overnight Index Average) + 4% per annum. SONIA is the rate of interest banks receive when they lend money to each other and is similar to the Bank of England base rate. While the fund aims for long-term growth, it still has the potential to lose value over some shorter time periods.

The fund's sustainable 'red lines' mean companies that violate the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption) and those incompatible with the aim of limiting global warming to 2°C are not considered for the fund. It also won't invest in companies that make more than 10% of their revenues from tobacco, alcohol, gambling and several other contentious industries. The team engages with the companies they invest in on a range of ESG issues and report on progress in their Responsible Investment Report (available on the BNY Mellon website).

The Responsible Investment team has power of veto over companies held in the BNY Mellon Sustainable Real Return Fund. This means the final decision is separated from the managers and helps provide an additional layer of challenge.

Over the past year, the managers have kept the split between the return seeking core and the stabilising layer broadly similar. They have however made changes within each of these sections.

Within the return seeking core, they have reduced exposure to alternatives, while increasing exposure to emerging market bonds. Emerging market bonds look attractive following the depreciation of a number of currencies, presenting what the team feel is a good entry point.

Within the stabilising layer the team have reduced investments in derivatives, government bonds and precious metals in favour of cash. That being said, the exposure to government bonds has varied significantly over the year. The period has seen a rapidly changing outlook for government bonds as inflation and interest rate expectations have been volatile and the team have reacted to this by increasing and reducing their exposure. The increase in the cash position reflects the higher interest rates now available following the interest rate rising cycle.

Culture

BNY Mellon is a large, US-based firm so the managers have a lot of resources at their disposal. Until mid-2019 they were part of the Newton brand, but even though the name has now changed to that of the parent company, the way the managers run the fund remains the same.

In September 2021, Mellon Investments merged its equity and multi-asset teams into Newton. So far this hasn’t directly affected the managers of this fund, although it has given them access to a larger pool of research analysts who could be of benefit.

We like that the fund managers are incentivised in a way that aligns their interests with those of long-term investors. However, there have been some significant fund manager departures in recent years and we continue to monitor this situation closely.

ESG Integration

The team at BNY Mellon (formerly Newton) believes responsibly managed companies are better placed to achieve sustainable competitive advantage and provide strong long-term growth. They’ve invested a significant amount of time and resource into their Responsible Investment proposition in recent years, including the hire of Therese Niklasson, the firm’s Global Head of Sustainable Investment, who we have long held in high regard.

All fund managers have access to a Responsible Investment app which centralises a variety of research providers’ data, as well as their own, to help identify material ESG and sustainability issues for a single company. It also includes a quantitative net-zero assessment tool to support their analysis of each company’s net zero transition plans.

In recent years, the firm has launched a sustainable range of funds which take ESG analysis further. They utilise the firm’s thematic research framework to identify and exploit sustainable investment themes. Within the Sustainable range, the Responsible Investment team has power of veto over companies held in the portfolios. This means the final decision is separated from the managers and provides an additional layer of challenge.

Overall, we think ESG risks are at the heart of this fund’s process of choosing which investments to use.

Cost

This fund is available at an annual ongoing fund charge of 0.97%, making it more expensive than the BNY Mellon Real Return Fund, which has a net ongoing charge of 0.74% for HL clients. While a slightly higher charge is to be expected for the additional sustainability analysis that goes on within this fund, we think the charge is on the high side and investors should be mindful this sets a higher hurdle for the managers to deliver positive returns. The HL platform fee of up to 0.45% per year also applies.

Please note the fund's charges can be taken from capital. This increases the yield but reduces the potential for capital growth.

Performance

Since launch the fund hasn’t performed as well as its official benchmark, SONIA +4%*, although it’s ahead of peers in the IA Targeted Absolute Return sector. Past performance is not a guide to the future. All funds will rise and fall in value, so you could get back less than you invest.

Over the past 12 months, the fund has underperformed both its benchmark and peers. The two main causes of this underperformance have been derivatives held within the stabilising layer and alternative investments within the return seeking layer. The managers have been concerned about stock market falls and so had derivative protection in place during the first half of 2023. However, stock markets generally rose, which caused these derivatives to lose money for the fund. At the same time, some of the alternative investments have struggled following the steep increase in interest rates. Many of these companies have expected revenues and profits a long way into the future, which are not as valuable now that investors can get a higher rate of return from cash.

It wasn’t all bad though, with investments in company shares generally adding value over the period, as did cash and some holdings in precious metals.

This is a very short period of time over which to judge returns though and past performance is not a guide to the future. Over the longer term we think the fund has the potential to beat its benchmark, although there are no guarantees.

At the end of October 2023, the fund had an historic yield of 2.62%. Yields are not an indication of future income and are not guaranteed.

Past performance is not a guide to the future. Source: *Lipper IM to 31/10/2023.