BNY Mellon Sustainable Real Return: November 2024 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 potential 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) 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.

The split of investments in the fund between the return seeking core and the stabilising layer is roughly the same at the end of October 2024 as it was at the end of September 2023. It had 66.2% invested in the return seeking core at the end of October and 33.8% in the stabilising layer.

Within the return seeking core, the managers have increased investments in shares from 34.3% at the end of September 2023 to 46.8% at the end of October 2024. They have reduced investments in corporate bonds, alternatives and emerging market debt within this part of the fund too.

Within the stabilising layer the team have increased the amount invested in government bonds and reduced the amount in cash.

Overall the team have been active in altering their investments within the fund, which is fairly typical for the managers, particularly during volatile markets.

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.

A dedicated Responsible Investment team exercises the firm’s voting rights, coordinates engagement with investee companies and contributes to public debate on ESG matters. The team reports on their engagement progress in their annual Sustainability and Stewardship report, and their quarterly ‘ESG meeting activity’ report (both available on the Newton website). They also offer a voting dashboard, which provides fund-by-fund search functionality and detailed rationales for votes against management and abstentions.

All fund managers have access to a variety of tools, including a “Responsible Investment reviews” 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, and a ‘net zero assessment’ tool assesses credibility of each company’s net zero transition plan. The firm has also launched a Stewardship app, a database which allows the team to better track progress on their engagement objectives, as well as outcomes from their engagement and voting activities.

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 0.86%, but HL clients benefit from an ongoing saving of 0.20%. This means you pay a net ongoing charge of 0.66%. Part of the fund discount is achieved through a loyalty bonus, which could be subject to tax if held outside of an ISA or SIPP. The HL platform charge of up to 0.45% p.a. also applies, except in the HL Junior ISA, where no platform fee 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.

SONIA + 4% per year can be a high bar for a fund that places most emphasis on not losing money during market wobbles. SONIA moves in line interest rate changes, so when rates are higher as we’ve seen in recent years, the fund’s performance hurdle is also higher. This makes it more challenging for funds that tend to be defensively positioned.

That said, this is what we would expect and, while the fund has underperformed its benchmark, it’s performed better than peers. And importantly, the fund has achieved its returns with much lower volatility than shares, providing important diversification and some shelter to investment portfolios during market shocks such as covid in 2020.

Overall, we expect this fund won’t lose as much as stock markets during market shocks and over the long term will generate positive returns with less ups and downs than shares.

Over the past 12 months, the fund has outperformed both its benchmark and peers. The biggest contribution to performance has been the investments in shares. The managers increased their investments in shares towards the end of 2023, which worked well for them as stock markets have performed relatively well over the last 12 months. The team have been active in managing their overall exposure to stock markets, including reducing the amount invested in them again during the summer of 2024. Overall, this has worked well for them over the 12 months.

It wasn’t just shares that added value though, investments in bonds, cash and gold all added positively to performance over the year.

In terms of negatives, some of the derivatives the team use to provide protection in the event of a large market sell off provided a negative return. Currency exposure also hurt performance overall.

At the end of October 2024, the fund had an historic yield of 2.68%. Yields are not an indication of future income and are not guaranteed.