Ethical investors split on gilts

Only 24% of investors apply ESG criteria to sovereign bonds

Sovereign bonds have long struggled to make a mark in ethical investing, given the perception certain governments fund questionable practices that would not sit well in many ESG portfolios.

According to a recent report by Cerulli Associates, only 24% of investors apply ESG criteria to sovereign bonds, compared with 85% who apply such criteria to investment grade corporate bonds.

Cerulli notes that the incorporation of ESG criteria into fixed income has been stymied by factors such as the role of ESG in credit ratings, the shortage of sustainability indices against which to benchmark performance, the scarcity of ESG-focused products, and the challenges of engaging with issuers, particularly sovereigns.

In the UK, a common perception among ethically-minded investors is that buying gilts is indirectly funding defence and arms.


Last week, the role of government bonds in ethical portfolios was brought to light after Coventry-based asset manager Ifunds launched a range of low-cost ethical portfolios combining passive investments with active risk management to reduce drawdown and volatility.

The four portfolios – cautious, balanced, growth and aggressive – use ETFs and tracker funds to gain access to major equity and government bond markets around the world. Ifunds said to qualify for investment in the range, companies must meet SRI criteria.

Ifunds uses Vanguard index funds for its Europe, US and Japan government bond exposure and the iShares Core UK Gilts ETF for its UK government bond exposure.

Stacey Ash, director and investment manager at Ifunds, said ethical is in the eye of the beholder.

“The trouble is you get into an ever-decreasing circle discussion about it,” he adds. “Naturally, we have thought about it and if you want to go down to the nth level, you could say ‘I invest in companies that pay corporation tax, where does that money go? It goes to governments’.

“Our view is that as long as you provide a clear message to the consumer about what you are doing, it is ultimately up to them to decide. We have got government securities in there because they are consistent as a risk management tool to build a balanced portfolio and if you don’t agree with that statement you can use somebody else’s.”


But the Rathbone Ethical Bond fund does not invest in gilts at all because of its strict ethical screening process, which excludes armament and high impact activities such as nuclear power.

Noelle Cazalis, assistant fund manager on the Rathbone Ethical Bond fund, says: “In order for us to consider investing in such securities, we would need the monies from a bond to be ring-fenced for projects that meet our fund’s criteria.”

Whitechurch Securities does not invest directly in gilts for its ESG funds, preferring to use ethical corporate bond funds such as Rathbones Ethical Bond and Kames Ethical Bond. Amanda Tovey (pictured), investment manager and head of SRI at Whitechurch, says the approach investors will take to gilts is subjective as the proceeds might not necessarily be heavily skewed towards contentious areas.

“There is the argument that for UK gilts only, a small percentage of the proceeds goes towards defence, the vast majority of the money goes to infrastructure spend, NHS, social security, so on balance the overall spend would be deemed in the public interest,” she says.

According to the Office for Budgetary Responsibility, defence is one of the biggest outgoings for the UK government. In 2018-19, central government departments are expected to spend £295.6bn on the day-to-day running costs of public services, grants and administration, £28.4bn of that is on defence.

However, Tovey adds: “If you were looking at government bonds in other countries the breakdown could look significantly different.”


Morningstar director of passive funds and sustainability research in Europe Hortense Bioy says it is clearly tricky to get ethical exposure to government bond markets because buying gilts, for example, can be seen by some as helping to fund arms/weapons.

“But not all investors would consider this sort of activities ‘unethical’,” she adds. “You have to draw the line somewhere. A country funds arms also to defend its people.

“When it comes to ethical or responsible investing, there are lots of inconsistencies, hypocrisy and unintended consequences. But that shouldn’t stop people from wanting to invest and consume more responsibly.”

Cazalis believes the UK government could do more to clarify its ethical stance.

“We would love to see the Treasury engaging more with ESG investors to see how the growing investor demand can be met. Certain other governments are already issuing green bonds,” she adds.

It could start by taking a leaf out of Ireland’s book. Last month, the National Treasury Management Agency (NTMA) raised €3bn from the sale of Ireland’s first 12-year green bond at a yield of 1.4%.

NTMA director of funding and debt management Frank O’Connor said at the time: “Sovereign green bonds are an innovative form of finance and it makes sense for Ireland to be at the forefront of developments in this space.”

– This article first appeared on ESG Clarity‘s sister site, Portfolio Adviser.