Our views

ESG: Unlocking the benefits for credit investors

Matt Franklin, Credit Analyst

4 May 2018

Whilst Environmental, Social and Governance (ESG) analysis has been established for some time in equity markets, focus is increasingly turning to how to integrate ESG considerations into credit portfolios. Given how important long-term sustainability is for lenders, we believe that clients can benefit hugely from the insight ESG analysis provides, but these benefits can only be unlocked if asset managers take an appropriate approach.

For managers looking for a quick fix for clients, the path of least resistance is to borrow from more established equity colleagues, replicating those ESG processes for credit portfolios. Using this approach, with its reliance on “off the shelf” screening tools, allows asset managers to rebadge their funds as “ESG credit” portfolios, but at what cost to clients? We believe that taking this path can be highly detrimental to clients, as it ignores a number of key nuances of credit – from the limited control and influence of unsecured lending, to ignoring the multitude of ways you can lend to a single company, as well as missing the opportunities of unlisted borrowers.

If not a copy and paste approach to ESG and credit, how can these factors be meaningfully integrated into fixed income portfolios? We believe that a bespoke approach is essential; taking account of the long-term social and environmental profile of the asset that we are financing, reflecting the unique characteristics of the asset class and tailoring to the way money has been lent. Our long-established focus on lending with security and covenants provides a strong foundation, helping to improve our control and influence with borrowers. This is enhanced by our in-house ESG experts, who tailor their analysis to the way to the way we have lent, adjusting their focus for each bond’s specific characteristics.

A key part of our integrated ESG and credit framework is engaging with the companies we lend to. Whilst many dismiss engagement from a lender’s perspective, seeing it as incompatible with the asset class, we believe it can be hugely beneficial to clients if done right. The key to our success is targeting our engagement with borrowers, focusing on where our likelihood of influence is highest. Whilst engagement with global behemoths such as Walmart is unlikely to yield meaningful results, focusing on companies without equity capital (such as housing associations) and those with a greater reliance on debt markets (regulated utilities) can lead to far more meaningful discussions.

We are very supportive of the industry’s growing, albeit long overdue focus on ESG for credit portfolios. However, only those with a truly integrated, bespoke approach that reflects the nuances of credit will be able to unlock the benefits.

For more detail on how RLAM incorporates ESG factors into credit analysis, listen to the webinar from our recent investment conference. A brief video on this topic is also available.

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.