Last week I listened to an ESG bond investment webinar by one of the world’s largest investors. Aviva plc is a British multinational insurance company and one of the top ten fund managers in Europe and the second largest U.K-based fund manager. The fund management business invests the group’s funds held for policyholders.
In this webinar, a panel of five staff discuss its environmental, social and governance (ESG) analysis.
Panel of experts
- Colin Purdie, CIO of Credit
- Liam Spillane, Head of Emerging Market Debt
- Tom Chinery, who is a Portfolio Manager for Sterling Investment Grade and also a co-Portfolio Manager on Climate Transition Global Credit Fund
- Justine Vroman Senior Portfolio Manager
- Richard Butters, Financials analyst within ESG corporate research
Colin, why do you think bond investors haven’t used their influence in the same way as perhaps equities has in pursuit of ESG up until now?
Use of voice as we say has always been easier in the equity space. Clearly, in the past the view has been in some areas that the AGM voting is the place for these issues to be raised, it’s where you get your audience with the executive of the company and that’s where you can make your question, raise your point, et cetera, and try and leverage. To some degree that has been successful.
What we have seen, we think for a number of years now if not decades, is that credit investors have a very loud voice. When you think about ESG, there has been a pivot within the capital structure more towards debt in the last few years. The cost of capital has been increasing, and that’s something that is impacting bottom lines. Companies have been required to sit up and take notice, and as a result of that I think some bond investors and credit investors have felt more emboldened.
The voice of credit investors will continue to increase not only because they’re providing more debt but because the cost of that finance and the ability to refinance all the time may change as conditions change. As a result, it seems only right that we use our voice appropriately.
It’s all very well and good engaging with companies, that feels relatively intuitive, it’s not a big leap on from the equity perspective to the credit perspective, but how does it work engaging with sovereigns and how does that differ between both developed and emerging markets?
I think it also has to be recognized that where we are on the journey of engagement is slightly different in some aspects in sovereigns as it is to corporates. In my world, experienced Emerging Market investors have long been engaging with sovereign issuers, but most of it has been focused on governance, typically. Some of it has been focused on social concerns, and of course they do relate to governance, but only more recently has that engagement picked up on the environmental or the climate lane. On that latter part, I think we’re a little bit more in the early stages from a sovereign engagement perspective relative to the corporate universe.
Finally, probably the most important point is philosophically it is a very different lens of engagement. I suppose put rather simplistically we have to recognize that for most of the countries that we are investing in, for most of us most of the time, we are not voters in that country. So, active ownership and stewardship has to be taken through a slightly different lens in that context.
It’s not quite alphabet soup, but green bonds, sustainable bonds, social bonds, rhino bonds, why on earth do we need all these various different types?
Whilst green bonds were the start of it, we’ve seen lots and lots of different structures out there, we as a house, we don’t particularly look at structure. It’s obviously interesting, you’ve obviously got to have an opinion on the structure because it feeds into so many different aspects of your rate to value analysis and your assessment of what the company’s doing, but we don’t buy bonds just because they’re green bonds, blue bonds, whatever it might be.
We really like these whole businesses saying, “This is what we do now, this is what we want to do in the future, this is where we think we can add value on XYZ, whatever it might be.” That could be a climate-related activity, that could be a governance, it could be a social activity, that’s what we really like about the SLB structure is it can fit any number of different parameters so long as they can be assessed and viewed over time.
Management of the companies then attribute a penalty or a benefit for achieving that in their bond structure. That gives a huge amount of accountability. Whether the penalty or benefit is material or corporate level, it’s material from a signalling perspective and an accountability perspective. It’s really aligning what bond investors are looking for in companies and making these big commitments with what the issuers themselves are doing. I think it’s really allowing us all to focus on the companies that are doing better or making more effort, sadly, from an ESP perspective. That’s really helps to feed into how we look at companies and how we assess them on an ongoing basis.
Justine, Tom was talking about companies that are doing better. I wondered from a sector perspective have you got any strong views in terms of which industries, which sectors are doing best or worst on the subject of ESG?
That’s a really difficult. I think you really need to take specific metrics for each sector and look at what is the most important problematic, which would be very different whether you’re looking at utilities or technology. I think where we can make a difference is, ESG requires a forward-looking qualitative assessment, which cannot be achieved by simply relying on third-party providers. What can be good for one provider is not necessarily good for another. Some end up with solutions which are closer to negative screening, which doesn’t distinguish between companies that have the best ESG performance, companies that are just scraping by, and companies that are excluded for the wrong reasons.
Similarly, solutions that only rely on carbon emissions will tend to exclude high carbon intensive sectors or companies which actually are going to be the most material when it comes to global decarbonation and meeting global warming. I think what we do is really try to identify the leaders, not only of today but the leaders of tomorrow, and clearly our large resources with 20 ESG analysts allow us to do different work of quality assessment and active engagement.
Richard what do you see as being the biggest challenge to integrating ESG in credit?
When we start drilling down into what other things we do, we apply ESG through things like quantitative tools and methodologies. We are very dependent to some extent on quantitative insights. We have a very large investment universe and to try and understand and bring everything together on how individual companies are are existing on ESG, sometimes data is incredibly helpful to do that. So we have our own proprietary ESG score which is applied to about 20,000 issuers across all geographies and across all different spectrums of credit ratings as well.
When we then start looking at how we can use ESG across credit within the different strategies, we then also start to see that there are different nuances between the different strategies, so whilst we have the quantitative view, which provides a baseline, what we then try and do is use the qualitative insights to help overcome some of the differences between the individual strategies.
If I was to just give you an example of that, you might have investment grade at one end of the spectrum which looks at very high-grade bonds, typically within a three to five year time horizon. Then we also have short duration assets, so money market funds, and within that we’re looking at what are the ESG risks within a six month to two year time horizon. Also, we have buy-maintain, and with buy-maintain the ESG risks start to manifest very differently there because you’re then starting to look out from a six month or two year time horizon to a 30 year time horizon. It’s very difficult to understand what the world will look like in 30 year’s time.
When you then start looking at all of these differences and multiple variables, applying ESG and integrating it well within credit can be very challenging. So, what we like to try and do is really use our active approach, from using insights from across the team, ESG analysts working alongside credit analysts to provide recommendations on companies. That’s how I’d summarize some of the challenges that we have.
Tom, putting this first question to you, would it make sense to buy bonds financing particular projects considered sensible but from corporate source offerings with a more questionable ESG record?
it’s something we have a lot of theoretical debates about how to go about directing our ESG investment. There’s a lot of people out there that focus on the use-of-proceeds of an individual bond. But it’s not quite how we think of our investment. If you think about the use-of-proceeds bonds, the funds that go towards your interest coupon payments and your principal repayment at the end of the life of the bond are fungible with the general corporate proceeds that companies use to pay their other bonds, coupons and principals.
We took the view that you should look at what the company’s doing holistically and therefore it feeds into our normal analysis process.
I had a question about sustainability linked bonds. I’ve heard a lot of concerns that issuers are basically choosing meaningless KPRs for the interest rate reduction and they’re not making a genuine commitment to sustainability. For example, the Port of Newcastle sustainability-linked loan where they’re decreasing Scope 1 and 2 emissions but still exporting hundreds of millions of tons of coal. How do you make sure that companies are genuinely making the sustainability commitment and does this represent a credibility risk?
It’s why we have a team of people like Richard and the credit analysts. There’s the ESG analysts, the credit analysts, and the portfolio managers. It comes back to what Justine was saying on this active investment strategy. We have to look at what we’re doing, and that’s not just what the companies are doing, that’s the structure we’re buying into. I think that it feeds into all the work we do to make sure we’re trying to invest in the best companies. Sustainability-linked structures, like all other structures, you’ve got to look at what’s going on within that. Is it additional, is there accountability within it, and all of that has to be assessed on a bond by bond and a company by company basis. That’s how we have to do it. I wouldn’t comment on the particular structure itself, it’s our normal business to make sure that what we’re investing is the right thing.
There was a really interesting case that we worked with alongside one of the credit analysts a few weeks ago. There was a U.S. midstream fracking company, or they were an operator, a supplier to the industry, and they were focused very much on providing water to the fracking process. What fracking is, for those of you who might not be aware or know, it involves pumping water combined with multiple types of chemicals into fissures within the ground, and then extracting gas and oil. What actually happens is the water is then contaminated, it’s full of toxic waste, and it needs to be stored in tanks. This creates a number of biodiversity challenges.
What was interesting about this green bond is that the use-of-proceeds of it were going to go towards improving the recycling rate of the fracking process. On the one hand, you might say, “This is improved, water recycling, that’s a good thing,” but when you then start applying it through this lens, what is the broader company strategy, and how are they contributing to broader sustainable outcomes, you then start ticking off a number of areas where it doesn’t actually meet that criteria.
So, if you were to look at the issue, first and foremost, it is predominantly based on midstream fracking, which in itself is an activity which is highly controversial. Secondly, whilst the use-of-proceeds were going to improve the efficiency of recycling rates, which is a good thing but you’re also potentially contributing to even more carbon emissions.
When you then start looking at issues like that, you then start to see you can’t just base a green bond or sustainability-linked bond individually based on the merits of what it portrays. You have to drill down into the detail.
How much are you willing to pay in order to get better ESG and how do you in particular, I realize there’s no single answer to that, how do you work out how much you’re willing to pay, how much risk you’re willing to accept?
So, the fact that a company has issued a green bond can suggest that actually, from an ESG perspective, they’re definitely pointed in the right direction, they’re doing the right thing. However, if you get paid more to take exposure to the same company in a brown bond, then there is an argument that you should be taking exposure to that company in the form of the brown bond because you’re still benefiting from the improving ESG sustainability of that company.