Environmental, social and governance themes have been at the forefront of many new equity investment strategies over the last decade, but their fixed income peers are beginning to catch up.
Over the past 12 months, European investment houses of all shapes and sizes have begun to latch on to the sustainability phenomenon and how it can be applied to bond funds.
DWS, Raiffeisen, and Assenagon are just three of the firms to have presented ESG corporate bond funds to the market this year, with more lining up to launch.
But might the investors’ demands for all things ESG cloud their judgement over a relatively risky asset class?
Rainer Haerle, head of global credit at DWS and manager of the DWS Invest ESG Global Corporate Bonds fund, doesn’t think so.
“ESG is a long-term risk management tool,” said Haerle. “If there is a short-term sell off due to a change in monetary policy, or a tweet, a bond with a good ESG rating will react in the same way as the others initially, but it may perform better in the long run.”
This is because using the “G” element of ESG criteria, managers can hunt out the best-run companies. It is not a new idea for long-term investors to seek out the best-managed companies, but ESG gives more items on a check list to look at.
Adding the “E” and “S” to the mix gives more elements to examine – and investor pressure will mount on those companies failing to meet the grade. For example, Rosenkilde has already seen the cost of capital increase for tobacco companies as many of the largest investors have excluded them entirely.
The importance of data
Leslie Sita, client portfolio manager within Lombard Odier’s fixed income team, said managers’ analysis, and the data needed to do it, on environmental standards is improving and is going to be a key element to bond investing.
She added that as bond investors venture further down the credit spectrum, their attention to ESG factors becomes even more important.
“ESG is a valuable tool to help protect investor capital,” said Sita. Managers and analysts can use the same set of data as that used by their equity colleagues, but search for an indication of solvency and the risk of downgrade rather than out performance.
Sita said: “We are not there yet, but doing extensive research is important. We should not just take ESG scores at face value.”
Something investors need to be aware of when allocating to ESG bond funds is their bias towards large cap companies.
Due to higher revenues – and therefore typically more investor demands of visibility – larger companies are most likely to allocate the budget to produce detailed ESG reporting. The better the data, the easier it is to rate the companies highly, meaning they are more likely than smaller counterparts to earn high ESG ratings.
However, for Edith Siermann, head of fixed income solutions and responsible investing at NNIP, an ESG score itself is not telling the whole story.
“Analysts need to dig deeper in underlying developments and issues to assess the overall ESG performance of a company and the momentum,” she said.
A fully-fledged process
Michael Hünseler, head of credit portfolio management at Assenagon, said the asset manager had outsourced the ESG analysis for its dedicated bond fund, launched in July, but it was able to take its own view on companies, too.
“We wanted a fully-fledged process,” said Hünseler. “Not just limited to exclusion, for example, and with some room to make investment decisions.”
Assenagon believes that companies should be – and are becoming – rewarded for making good, long-term corporate decisions about governance, the environment and the society around them.
Alexei Jourovski, head of equities and a member of the Unigestion Executive Committee agreed that better visibility of how companies were addressing these criteria – predominantly in the equity market so far – was already having an impact on the price investors were willing to pay to own them.
He said that the additional data points required for credit analysis made bond investment an even better candidate than equities for ESG consideration.
For Hünseler, the forward-looking commitments made by ESG-aware companies will mean they become the most attractive investment proposition and incur a “scarcity premium” over time.
For equity investors, this could take the form of higher share prices or dividends; for bond investors, although potentially yielding less than non-ESG conforming companies, the risk of future nasty surprises is likely to be reduced.
Low rates impact
This potential reward could be a boon for investors as central banks around the world seem set on keeping interest rates low – and add to the argument to invest in corporate bonds in general.
“Look at the pickup of corporate bonds compared to government-issued securities,” said Haerle at DWS. “Even 1% is relatively attractive to what else is out there, and even at this stage in the cycle, we are still not seeing rising default rates in investment grade bonds.”
In its latest outlook on the credit market, analysts at Moody’s said they expected corporate profits to outrun any major risk of default – at least in the short term.
This is good news for investors with a set return target or regulatory need to allocate to fixed income. Understanding a company from an ESG lens may make all the difference when the market finally turns and companies start hitting the wall.
“ESG is going to become a lynchpin in any decision,” said Hünseler, highlighting how the current low cost of borrowing was keeping companies that might otherwise default in good health.
And it doesn’t stop there.
Jourovski at Unigestion said: “Clients are taking a holistic approach to ESG in their portfolios – if there is bad news for a company it hits both their equities and bonds. And investors want to see how it impacts other holdings — the data needed is the same.”
