Contributing to sustainability by financing the right corporates
Integrating a stronger focus on sustainability is very suitable for fixed income. We prefer inclusion over exclusion and see engagement as an opportunity to initiate change. Sustainability can be incorporated in a bond portfolio without drastically changing characteristics such as duration, credit quality and diversification.
These days special attention is drawn to the importance and power of sustainability, and to the role that we can play – as citizens, as corporates - in contributing to a more sustainable economy and prosperous society. Ranging from campaigns at the local shopping centers, corporate events for entrepreneurs and education sessions for children - every part of society had an opportunity to be engaged. But what role can you play as an investor? The theme of sustainable investing has been gaining ground steadily in the past decades. Focusing on companies that score high on environmental, social and governance (ESG) criteria is often associated with investing in equities, but this focus can also be applied in Fixed Income. In fact, many portfolios are not (just) invested in equities. You can move from traditional fixed income investing towards a more sustainable portfolio, while maintaining the same portfolio characteristics and targeting the same financial returns.
Financial returns and investing in a more sustainable economy and prosperous society go hand-in-hand.
Focusing on the upside or avoiding the downside?
In Fixed Income, embedding environmental, social and governance (ESG) aspects in the investment process is slightly different from the way this is done in equities. Given the more conservative risk profile of bonds and therefore smaller upward potential, the first and foremost objective is to avoid downside risk. Looking at ESG aspects broadens the scope of potential risks that might affect the sustaina¬bility of a company’s business model and in fact, analysing such risk factors is closely related to the traditional fundamental analysis of companies.
Taking into account a broader set of risks may result in exclusion, which is often seen as the first step towards a more sustainable portfolio. There are various ways to exclude investments – based on sectors or countries, based on certain norms or based on certain behaviour or activities. This creates an important starting point, as it defines with what kind of companies or activities you certainly do NOT want to be involved in. But it does not yet target those compa¬nies that you do want to invest in based on the conviction that their business models may contribute positively to a more sustainable economy.
That is why we believe that there should also be a strong focus on inclusion. Finding those companies that score positively on ESG aspects, adding value to the world we live in and to capture tomor¬row’s financial growth drivers is key in our investment process. One of the inputs that can be valuable is the information from external data providers such as Sustainalytics. We do believe however that it is of vital importance to do our own homework and not just rely on external data, using the insights and skills of our experienced portfolio managers to perform a thorough in-houses analysis and add value in the investment process.
An example of looking at a company in greater detail is a world-leading chemicals supplier producing high-tech polymer materials – in a sector that is not by definition very ESG-friendly. On the financial side, ratios are at an extremely conservative level. The company is a cost leader and faces positive demand fundamentals. Their profitability improved substantially from below to above sector average and even above direct peer levels in recent years. They have built up flexibility for share repurchases and higher dividends, while maintai¬ning M&A options. With regards to ESG aspects, they also score well above sector averages. They rank in the top 4 of their peer group and receive high scores on sustainability from external agencies with no significant controversies. What is unique about this company is that they use carbon dioxide as raw material for chemicals and plas¬tics and the ability to have shown a significant reduction of energy usage by for example coating at low temperatures. This could prove a true game-changer for future developments in the sector.
Having said that, finding today’s ESG-‘leaders’ is one thing, but fin¬ding those companies that are shifting their current business model towards a more sustainable one are equally important. This is known as ‘momentum’, where you choose those companies that can achie¬ve the largest improvement. They might not yet have a high ESG-score, but they are the catalysts that help us move forward towards for example more renewable energy and cleaner transportation.
While engagement is something that is often associated with equities, we actively engage with companies we (want to) invest in. We ask questions on ESG-related topics and assess their approach to topics such as climate risk and social impact. In case we are not satisfied with their efforts or willingness to adept when needed, we divest, but our ambition is to ‘engage for change’.
Excess return of fund versus benchmark as per end of August
* Benchmark: Bloomberg Barclays Euro-Aggregate Corporate ex Financials [Bloomberg Barclays Euro-Aggregate until 15 Dec 2011]
** Benchmark: Bloomberg Barclays Euro-Aggregate Corporate annualised for periods longer than 1 year
Taking one step further into impact
When going one level deeper into the portfolio, we look at how the proceeds of a certain bond are used and what their impact is on environmental and social aspects. This is where Green, Social and Sustainability bonds come in, of which the Green Bond market is currently the largest. These bonds specifically target positive, measurable environmental impact. The Green bond market is growing rapidly, both in corporates as well as sovereigns, allowing for a growing set of investment opportunities. As mentioned earlier, we believe it is still vital to do our own homework and assess both the issue and the issuer on their merits, not just relying on external data or labels, to really choose the right investment that can make a positive contribution.
Holding on to the old features or moving into a new universe?
You can choose to move your traditional portfolio into more sustainable investments without having to change portfolio characteristics such as credit quality, duration and diversification – unless of course you want to. Our investment strategies in sustainable credits and green bonds illustrate that investing with a focus on sustainability does not compromise returns and if anything, it provides a broader view of potential risks, mitigating the downside. When applying certain exclusions, the universe still remains large enough to build a diversified portfolio, with the ability to maintain the same features in terms of credit quality, duration and expected return. In fact, our sustainable credit funds have outperformed the regular investment grade bond index over the past years (since inception). In the case of Green bonds, the investment universe does look a bit different – and for good reasons – but depending on the client’s objectives and constraints, an appropriate combination can always be found.
Coming back to our earlier question – what role can you play as an investor? You can finance the right companies that generate a positive contribution to a more sustainable economy and prosperous society. Many opportunities exist in the bond market to exclude certain investments and moreover, to include those companies that do contribute positively. The universe is large and diverse enough to maintain credit quality, duration, expected return and diversification. And for those who want to take it one step further, investing in Green Bonds can create measurable impact. The question is no longer why, but why not?!
How can shrinking demand boost revenue?
As traditional sectors shrink, sustainable ones grow. Successful companies have to create new business models, tap into new resources, and find new ways to turn waste into value. These companies won’t just survive into the future, they’ll thrive in it – and that’s where we’ll find investment opportunities that make a difference.
Find out more at sustainable.nnip.com.
Download the article:
This communication is intended for MiFID professional investors only. Click “Read more” for the full disclaimer.