Stewardship and ESG integration
The investment philosophy is rooted in the conviction that high yield corporate fixed income investing is first and foremost about risk control. Default risk is the dominant risk factor, and all portfolio investments must meet stringent, and quantifiable minimum 'margin-of-safety' requirements.
Secondly, the investment philosophy strives to never buy credit risk at the wrong price, utilising a default-adjusted, yield and spread methodology. This approach involves maximising the default adjusted yield and spread of a diversified portfolio.
We believe the optimal, risk-adjusted investment process combines both dynamic fundamental, bottom-up credit selection, with continuous top-down portfolio risk management systems.
Key factors such as corporate governance, business practices, industry and contingent liabilities related to environmental issues are researched thoroughly and heavily influence investment decisions. Third party specialists that have developed specialised ESG rating methodologies are also used to supplement core credit analysis. ESG risk receives further diligence through direct interaction with management, SEC filings and financial statement and footnote analysis.
Assessment and monitoring
The ION global database allows us to effectively analyse and report ESG ratings across many different securities, industries and corporate issuers. In addition, it allows us to effectively manage ESG factors across multiple portfolios. ION helps us determine how ESG influences returns and improve performance over the long term. ION can also assist us in implementing processes to deal with controversial investments where there may have been differing views.
As part of our investment process, we have integrated a third party provider that specialises in ESG risk analytics and metrics into our proprietary Investment database (ION). The external research and proprietary ESG risk database provides ESG ratings that allow us to evaluate issuers relative to their industry peers. All of this information is centralised in the ION database and is shared across our fixed income teams globally.
We have taken an active approach when trying to identify and assess the importance and materiality of each ESG issue. When investing in an individual company or security, we analyse certain factors such as community relations, employee relations, corporate governance, environmental issues and any contingent liabilities. Other relevant topics, such as executive compensation, employment conditions, and any other controversial impacts the business may have on the environmental ecosystems, including pollution, are risk assessed and considered heavily in whether an investment is deemed appropriate or not and in the relative and absolute price of the security.
We have determined that screening out issuers that have undesirable business models or which do not generate a positive impact is insufficient. Investing in companies that are focused on improving their sustainability has the potential to protect and enhance our investment returns. Most issuers can benefit via continuous improvement along a wide range of areas such as energy efficiency, workplace inequality and devising conscious environmental policies.
ESG risk assessment can be enhanced through engaging with management, specialty ESG rating services such as RepRisk and Sustainalytics, other fixed income investors and additional due diligence with industry consultants. This entails a forward-looking approach with the goal such that the benefits and increased value will accrue to investors.
We don’t view ESG factors as being more difficult to implement for fixed income investing. Indeed, many ESG components are fully captured in our fundamental credit analysis and investment process. While it may appear that fixed income investors have been slower to adopt ESG investment processes, it’s more accurate to characterise it as being less visible, because it is typically expressed through a non-public and less active approach given the creditor position.
Fixed income investors are more likely to abstain from making an unsuitable fixed income investment in a company that has an excessively high ESG risk profile. However, public and private equity investors are much better equipped to leverage their position as owners to effect change on a board of directors and executive management team to implement changes to a company's business practices.
We believe that a strong commitment to stewardship is an essential component of a strong approach to responsible investment (RI), and that embedding RI into the core of our investment activities is in the best long-term interests of our clients. For more than a decade we have systematically and progressively improved our practices and processes across our investment capabilities globally.
(Source: First Sentier Investors Responsible Investment & Stewardship Report 2019)