ESG playbook for bond investors needs a rewrite

The author is a portfolio manager at Barksdale Investment Management and co-author of ‘Undiversified: The Big Gender Short in Investment Management’

In order not to stay out of ESG’s gold rush, a growing number of bond companies are now offering environmental, social and government funds. Investment banks have created tools that will help regular income managers improve their investment portfolios.

However, the structure of the corporate bond market and the nature of creditors’ relationships with managements indicate that the ESG book needs to be rewritten if bondholders want to bring about a change in corporate behavior.

For the avoidance of doubt – I believe that good E, S and G methods can correspond with excellent returns. As a co-author of a book on the importance of gender diversity in investment management and as a shareholder and employee of a company owned by a majority of women, I am an avid supporter of “S” and “G”.

Despite our commitment to diversity and the frequent questions about ESG strategies, the company I work for is, explicitly, not an ESG manager. We do not tell our clients what should be in a socially responsible portfolio. Our firm must balance customer requests with the resources needed to create a relevant, tradable and blessed ESG framework in compliance.

These resources do not necessarily reside in smaller companies, as company research is just one of several tools for better performance. In stocks, Alpha – or the ability to beat the market – is about choosing good stocks. In fixed income, Alpha also includes managing the portfolio’s sensitivity to interest rates, allocating a segment and selecting the best bonds in the capital structure.

To analyze whether Apple is a good stock, a company may hire an analyst who is only responsible for covering the technology sector. But a call for Apple bonds may fall to an analyst who oversees several major sectors, or a corporate bond expert who looks at all industries to determine relative value.

The structure of the investment-grade research process has led some bond shops to create ratings using ESG ratings available in Bloomberg, from various sources. But unlike credit ratings, so far they are ambiguous, and sometimes contradictory, in their ability to identify good corporate practices.

Bond investors do not take credit rating agencies in their word about the company’s financial health quality. Telling a potential customer that the credit rating drives the portfolio building will not help him win a client mandate choice. But this approach has worked for some executives when using ESG ratings.

One argument for investing in ESG is that investors with a sustainability mindset can influence a company to make positive changes. But fixed-income executives do not vote in stocks, and involvement with management is usually limited to a “road show” on a new issue.

Creditors have two tools (so far unused) to influence corporate strategy. We could boycott new bond issues. But it will be hard to break our habit on the new issue. Bags have to reinvest cash regularly thanks to coupon payments and bond redemption. The new issue calendar does not always fit with the ESG shopping list.

Our second tool will be commitments that require meeting or advancing defined ESG targets. This will require a substantial change in bond contracts. Investment-grade bonds have minimum benchmarks, while high-yield benchmarks focus on balance sheet indices.

Companies have given us a weak version of it with “ESG bonds.” But contrary to the traditional bond convention, which requires compliance with the corporation level, ESG bonds only require its issuer to invest the consideration in favor of the stipulated use. And even that is a bit of a consideration. knowledge.

Where does the fixed income go from here? In the optimistic case, we work with our equity colleagues to present a unified front in dealing with companies while collaborating more with ESG rating agencies. This approach requires more resources, given the pressure of fees and increased technology spending. And it ignores the potential for conflict between bonds and capital perspectives and priorities.

I hope that a considerate ESG discussion of bond portfolios, which will prevent a slight ticking, will lead to a significant development of our investment process. But I am skeptical if what has happened in fixed income to date has made a big difference in the world. -ESG if they want to influence company behavior.

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