What's the latest with Ethical Plan performance?

Even for an experienced investor, a drop in your Plan’s value can be unsettling. This is why we wanted to provide an update on why we've experienced a drop in performance and why the impact has been greater for our Ethical customers recently.
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This year, many new investors may have experienced their first stock market correction which is a period when the financial markets go down by more than 10%. Although market performance can fluctuate over the course of your investment journey and is just a natural part of investing, even for an experienced investor, a drop in your Plan’s value can still be unsettling. This is why we wanted to provide an update on why this is happening and why the impact has been greater for our Ethical customers recently.

Why has Ethical Plan performance dropped?

The start of 2022 produced a perfect storm for market volatility, with lingering Covid-19 uncertainty, Russia-Ukraine conflict, and ongoing inflationary pressures lifting interest rate expectations.

By mid-February, most major stock markets were below the point where they started the year, and bond prices had also fallen due to tighter monetary policy and anticipation of future action - mainly the forecasting of interest rate rises.

In order to explain how these factors influenced the performance of our Ethical Plans, first, you’ll need to understand how they’re constructed. With ethical investing, we aim to strike a balance between providing an investment plan that supports your long-term financial goals, helping to contribute to positive environmental, social, and governance (ESG) changes and ensuring you are invested in line with your values.

At Wealthify, we aim to exclude 4 core industries from our Ethical Plans. These are:

  • Weapons manufacturing
  • Gambling
  • Tobacco
  • Adult entertainment

We also use actively managed ethical funds where possible as we believe that a hands-on approach and dedicated research teams help us to achieve the core principles of ethical investing. This results in a more concentrated Plan, with fewer companies being included compared to the passive funds we use in our Original Plans.

We closely review all the underlying companies in our Ethical Plans using in-house tools on an ongoing basis, to make sure that each company aligns with our core exclusions, and we constantly engage with fund managers to understand their views on key holdings. We do this every month, and the results from our February screening showed minimal exposure to gas and oil and no exposure to coal and airlines.

Total exposure of exclusions in Wealthify's Ethical Investment Plans

There are also a number of sectors that we don’t strictly exclude but we believe it is important to be as transparent as possible about our exposure to them. These are sectors that comprise of things such as fossil fuels, metals, alcohol, chemicals, and airlines. Our exposure in these areas is minimal thanks to the rigorous screening and engagement processes that our fund managers undertake.

When prioritising what to invest in based on positive ESG outcomes, many fossil fuel companies fail to meet the environmental criteria that is needed in order to be included in an ethical or sustainable fund. Similarly, many banks and financial companies are lagging when it comes to having an acceptable level of social and governance criteria that they’d need to be included. As ethical investing continues to grow, many companies within these ‘sin sectors’ are introducing policies and frameworks that look at addressing these social and governance shortfalls to try and become ESG leaders within their sector.

In terms of performance, we have seen Ethical Plans harder hit this year than their Original counterparts. This impact has been seen across all investment styles (or risk levels, as you might call them), but given the comparatively short time horizon it has not affected the long-term views of our fund managers or investment team. It is worth remembering that some years, such as 2020, Ethical Plans outperformed their respective Original counterpart – and why we discuss taking a long-term view and invest based on your values rather than on temporary factors. Here are some of the key factors that have influenced the performance of our Ethical Plans this year.

Energy stocks

Since the start of the year, the energy sector has been sitting at the top of the pile in terms of market performance. This is due to three main causes:

  1. The increasing cost of oil and natural gas,
  2. The resurgence in the manufacturing sector,
  3. The conflict between Russia and Ukraine, as Russia is the one of the largest oil and gas exporters in the world.

It’s also worth noting that rising energy prices are also a contributor to the increase in the Consumer Price Index (CPI), which is a key measure of inflation in the UK.

As our Ethical Plans have minimal exposure to the energy sector, Ethical Plans have not benefited from the boost in performance this sector has seen. Instead, we invest in a number of different sectors that meet our core exclusion criteria and are helping to contribute to positive ESG outcomes. In our case, this is largely the technology sector, which has unfortunately, been the sector hit hardest by the outlook for future interest rates.

It is important to remember that the outlook and future expectations are the things that drive prices, and not the past. For example, when companies announce their quarterly earnings results, it’s not simply the amount of profit they’ve made that drives the price, but rather how it compared to what was expected and the guidance provided by the company for what to expect going forward.

Table showing MSCI returns since the start of 2022

Source: Bloomberg

Technology stocks

On the other end of the scale to energy, technology stock performance has not been as favourable so far this year. This is because tech stocks are more sensitive to rising interest rates, due to the way current share prices are valued, and the rapid growth that’s expected of them.

One of the most widely used methods to value share price is by looking at what the future potential value of a company’s earnings are, based on their worth today – this is called the Discount Cash-flow model (DFC).

The future earnings of any company are dependent on the economy, the way the company is managed, and the nature of the products/services offered. So, when any of these factors change – for example, due to interest rates increase – the future earnings in today’s value is reduced, which may result in a lower share price.

It’s important to note that share prices worked out using a DCF model are heavily reliant on forecasts, best guesses, and many assumptions that are subject to constant revision. This is especially important as many growing technology companies aren’t expected to make large profits in the near term. Instead, the expectation is that they’ll make significant profits in the long-term. However, the discounting of these combined with increased uncertainty makes their stock price decline.

Investors are not declaring the age of innovation dead. Far from it! They are just more concerned about the outlook at the moment.  

Inflation

Controlling inflation is one of the main objectives that central banks try to achieve, alongside promoting sustainable economic growth, and reaching full employment.

Interest rates are one of the tools that central banks use to control inflation, and simply put, if inflation is rising beyond target levels (which is 2% in the UK) for a long period of time, then they’ll increase interest rates to combat this.

Similarly, interest rates are reduced when inflation is consistently below target levels. One of the main issues facing central banks across the world right now is rising inflation, and to understand why interest rates have increased, we need to look at why inflation is rising.

COVID, savings and supply chains

As economies around the world emerge from the restrictions and suppressions caused by the COVID-19 pandemic, many people were limited in what they could do with their money. For long periods of time, the service sector was effectively closed, and spending was largely confined to online purchases and supermarket staples.

The UK savings ratio (household savings as a proportion of household income), peaked in the first half of 2020 at 23.7%, then spiked again in the second half of 2021 to 18.4% following periods of lockdowns and increased restrictions. It was a similar story in the quarterly data released for the US, peaking at 26.1% and 20.5% over the same period.

Chart showing proportion of income saved by households over the years

You may be wondering why these statistics are relevant today. And the short answer is, many of the issues caused by Covid-19 restrictions are still very much impacting the markets, especially when it comes to supply chain shortages. It’s worth pointing out, however, that there are still very different levels of success in the vaccine rollouts between developed and emerging markets.

China is still operating a zero-tolerance approach to Covid-19 cases, and many factories are still being forced to shut. Workers are also in short supply, and deliveries are being delayed which continues to ripple through global economies. One example of this shortage is semiconductor chips, as most of this production happens in Taiwan, China, South Korea, and other far-east regions where strict measures are still in place to tackle rising Covid-19 cases.

As demand exceeds supply, and changes in production lines limit the speed in which these chips can be produced, the price of semiconductor chips has increased, along with production costs for any products that are reliant on them.

But not only has the cost of production increased, but shipping costs have also gone up. As an example, the average cost of shipping goods via freight from the far-east to parts of Europe and the US pre-pandemic was just over £1,000. Now that same service costs around £7,000, and it reached highs of £7,700 in September 2021.1

What our fund managers say

We reached out to all our ethical fund providers to discuss the short-term performance we’ve experienced and to better understand whether the recent volatility would affect their management processes.

The key themes raised by all our fund managers included inflationary pressures and the future interest rate increases that caused the revaluation of high-growth companies. The other common theme is the high-quality nature of the underlying companies which have been selected for their ESG properties, strong balance sheets, and cash reserves.

The forward-looking view of strong earnings is shared across the ethical fund managers, and their conviction to hold on to the investments in these companies remains positive. This recent market volatility has provided an opportunity for managers to review the mix of companies and find pockets of value in a market correction, which has affected some companies more than others.

The actions we’ve taken

In January, we made some changes to reduce the amount of longer-term bonds in favour of shorter-term bonds in our Cautious, Tentative, Confident, and Ambitious Plans.

We expect inflation to ease through 2022 as the world (and especially supply chain pressures) begin to normalise. But while inflationary pressures remain, shorter-term bonds are typically less sensitive to changes in interest rates and will act to dampen volatility. In addition to this, we increased customers’ shares in the US and Europe (excluding the UK), as we believe these to have been disproportionately affected by the recent volatility.

Our rigorous selection process has identified these ‘best of breed funds’ based on their process, track record, and the value for money they provide on a long-term basis. Through our extensive due diligence process and ongoing reviews, we look through the short-term market volatility and focus on the investment objectives and recovery ability that our Ethical Plans are designed to achieve over the longer term, whilst keeping a watchful eye on financial markets so we can act in your best interests as opportunities unfold.

  1. Bloomberg data

Please remember the value of your investments can go down as well as up, and you could get back less than invested. 

Past performance is not a reliable indicator of future results.

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