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    Responsible investment in fixed income quarterly update

    Responsible investment in fixed income quarterly update

    31 July 2020 Responsible investment, Fixed income
    Q2 2020

    Highlights

    • Market turmoil in the wake of the COVID-19 pandemic led to a focus on how sustainable portfolios performed, with our analysis suggesting an additional focus on environmental, social and governance (ESG) issues could have helped performance for some investors
    • In the US, the Department of Labor proposed restrictions on retirement plan investments, which may affect investments in sustainability-focused portfolios; this came as an influential committee called on the SEC to introduce an ESG disclosure framework
    • In Europe, the European Commission published several draft delegated acts seeking input on how insurers and asset managers integrate sustainability into their investment, advisory and disclosure processes

    Regulatory and industry news

    • Market turmoil resulting from COVID-19 sharpened the focus on how sustainable investment strategies performed: Our research suggested that sustainability biases could have supported performance. Our paper exploring how European credit investors might have benefited over the period of volatility through March and April from having an additional focus on ESG issues is available here.

    • US Department of Labor proposes restrictions on ESG investments: On 23 June, the Labor Department voiced an amendment to the Employee Retirement Income Security Act of 1974 (ERISA) that means economic interests must come before “non-pecuniary” goals when making 401(k) plans and pension decisions. By specifically naming ESG investing in this proposal, the proposals could undermine demand for such funds.1

    • Committee calls on SEC to address ESG disclosures: After several years of contemplation, the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee has recommended that the SEC introduce an ESG disclosure framework. Among other points, the committee stated that investors need reliable ESG information on which to base investment and voting decisions, and that it would ensure flow of capital to US markets and issuers (rather than to other markets with more reliable ESG materials).2

    • European Commission consults on how insurers and asset managers integrate ‘sustainability’ into their operations: The European Commission published six draft delegated acts for consultation, proposing material amends to the UCITS, AIFMD, MiFID, IDD and Solvency II frameworks. The pieces of legislation would require insurers and asset managers to integrate sustainability into their investment, advisory and disclosure processes. This is the latest of moves by the European Union to encourage investors to encourage sustainability.3


    Insight Investment decisions reflecting ESG factors in Q2 2020

    Sector Asset class ESG risk factor Comments Investment decision
    Real estate Investment grade (active) Governance Individual spearheading improvements in governance and transparency left the firm. Complex governance structure at the company so we saw this as negative. SELL
    Real estate Investment grade (active) Governance We noticed a number of governance failings in Nordic property companies which started to look like a trend. We analysed our data and identified the issuer as a name which had a poor governance profile. Sold the hybrid issue as a result, which did not appear to be pricing risks adequately. Senior issues looked like better compensation for risk so held. SELL
    Automobiles High yield Governance Poor financial planning and aggressive accounting in a high-growth environment. Failure to understand why it makes sense to have callable bonds by senior management. SELL
    Automobiles High yield Governance Operational failures in markets resulted in significant cash deficits. Funded with debt, instead of equity or CB bond. No liquidity runway. No Brexit planning. AVOID


    This is an illustrative list of investment decisions affected primarily by ESG factors, selected to demonstrate the role of ESG analysis in our research and decision-making.

    Impact bond issuance by sector and year

    Impact bond issuance by sector and by year

    Impact bond issuance by sector and by year - chart 2

    Largest impact bond issues in Q2 20205

    Issuer Issue type Size of issue Bond type
    UNEDIC ASSEO Government €4.49bn Social
    UNEDIC ASSEO Government €4.36bn Green
    African Development Bank Corporates $3.10bn Sustainable
    Nederlandse Waterschapsbank NV Government €2.19bn Green
    Hungary Government International Bond Government €1.69bn Sustainable


    Insight impact bonds ratings in Q2 2020

    Our analysis of 28 impact bonds issued in Q2 2020 resulted in the following ratings:

    bonds were rated green, indicating the bond meets Insight’s minimum sustainability requirements
    bonds were rated amber, indicating there are weaknesses in the bond with regard to sustainability
    bonds were rated red, indicating the bond does not meet Insight’s minimum sustainability requirements


    Sample of Insight Investment's impact bond analysis in Q2 20206

    Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
    Pearson Funding Plc Social Yes Yes Yes
    Analyst assessment: As an education bond , the bond has clear criteria for projects that could create a positive social impact and is aligned with the social bond principles. The issuer could have provided more information on exactly which category the proceeds would be used for and the extent of financing vs refinancing . However, this is an example of a best-in class issuer and there is a strong process for evaluating eligible projects, justifying the rationale for a green rating.

     

    Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
    Credit Suisse Green Yes Yes No
    Analyst assessment: The framework notes that proceeds will mainly be used for refinancing projects, with a minimum 20% new financing to be allocated by the end of day of issue or within 12 months at the latest. A green financing committee is responsible for final selection of projects, with three steps for selection and evaluation (including financial due diligence, ESG and impact evaluation). There are limited details on how environmental risks are addressed.

     

    Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
    Bank of America Corporation Social Yes No No
    Analyst assessment: There is a lack of information on how much is going to financing vs refinancing . It seems the framework has been verified by the ICMA, but this is not completely clear. Some of the wording around impact is not very clear on how often they would provide reporting and some KPIs are noted but, again, it is not clear if/when they will provide reporting or include KPIs rather than case studies alone. Compared to other COVID-19 social bond issuances the framework itself lacks detail and the ambiguity of the impact reporting is not sufficient to measure the overall impact of the bond. On the positive side, how proceeds will be used are more specific compared to other issues, but alone this is not enough to justify a higher rating.
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