Sustainability
At TwentyFour, environmental, social and governance (ESG) analysis is integral to our primary goal of delivering capital preservation and performance to our clients.
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We believe engagement should be a constructive, active dialogue between investors and companies on all aspects of their ESG performance.
While fixed income investors do not have voting rights in the way shareholders do, larger firms typically issue bonds multiple times a year, which puts bondholders in a strong position to be able to influence corporate policy by engaging with management on an ongoing basis.
At TwentyFour we aim to engage regularly with the management of every issuer whose bonds we hold in our portfolios, to better understand their ESG strengths and weaknesses, monitor their direction of travel, and overall encourage better ESG practices.
As part of our commitment to the UK Stewardship Code we publish a quarterly summary of our engagements with bond issuers, along with details of any resulting investment decisions, at the bottom of this page.
ESG investing is a fast-evolving discipline, and approaches can vary markedly from manager to manager. We therefore believe this makes the quality of the ESG data used in different scoring systems critical to outcomes, and even more so in fixed income, where we think data provision is improving but still well behind the level we see in the public equity markets. Because of this, we regularly engage with our external data providers and push them to extend their output.
We take our stewardship responsibilities seriously and look to always act in the best interests of our clients. We conduct a significant amount of due diligence on issuers with whom we invest, which enables us to avoid companies we believe do not meet our high standards in strategy, performance and/or ESG factors.
The general principals of our engagements are not fund or geography specific. Global fixed income markets are large, diverse, and complex. As such our approach is designed to retain a dynamic approach to serving our clients’ needs. In general we will engage on any topic as and when we feel it is in our clients’ interests to do so.
Investment or ESG issues can arise post-investment, and where we are concerned about specific ESG matters, management behaviour or treatment of bondholders, the portfolio managers will engage with the appropriate senior management or board member of the company involved. Within our proprietary ESG model, housed in our Observatory portfolio management system, we have a template which enables portfolio managers to log any company engagement by the following steps:
Our system is also able to capture and log any associated email correspondence, write-up, blog or any other related documents to build a detailed history of our engagement with every bond issuer.
We generally keep such discussions private as we believe better outcomes can occur this way, but we have on occasion published blogs discussing issues that we have found difficult to resolve and we felt deserved to be brought to our clients’ or the broader market’s attention.
For example:
Generally, if we have not been able to resolve an issue satisfactorily, we would not invest in bonds issued by those companies, however we would continue dialogue to ensure, as far as possible, the company in question understands why we are not investing in its bonds and that we are kept up to date with any developments including changes in management behaviours. If we are already invested in the bonds, it is possible the matter will result in us exiting the investment, at which point transparency may be delayed to avoid compromising the interests of our clients.
As a signatory to the existing FRC UK Stewardship Code we publish quarterly on our website the following engagement information:
Number of Borrower meetings / updates
Number of corporate actions
Summary of Corporate engagements
We engaged with Lloyds as part of our Carbon Emissions Engagement Policy. The focus of the engagement was in regards to the steps they are taking to reduce scope 3 emissions and broader firmwide environmental policy.
Lloyds is a founding member of the Net Zero Banking Alliance. In their ESG strategy, set out in February 2022 and outlines their 2050 net zero plans, they target a 50% reduction in financed emissions by 2030 and a 41% reduction in the carbon intensity of their residential mortgages by 2030. They have also set targets for affordable housing and diversity in their workforce. During our engagement they highlighted that the key challenges lie within mortgages and agriculture – they only have a limited exposure to fossil fuels (less than 1% of their lending to this sector). Their climate transition plan consists of target setting for both the bank financed emissions, which covers a major proportion of their lending (including oil & gas and power generation but mostly focussed on the motor and residential mortgages division), and the emissions financed through its subsidiary Scottish Widows. Their plan to tackle the residential mortgages division consists of: (1) educate customers on the energy transition; and (2) offer green products such as cashback products for those with an EPC rating of A or B, or those completing an eligible green home improvement, both of which create incentives for borrowers to make energy improvement. Additionally, they have partnered with renewable energy firm Octopus Energy in which Lloyds provide the financing for electric heat pumps and Octopus Energy carries out the installation. Similar to other banks we have engaged with, Lloyds reinforced the challenge that the UK housing stock is very old and while this partnership is in its early days, government incentives for households are lacking and as such more industry support is needed for households to make these energy improvements. Lloyds are looking to harness their position as the largest lender of UK residential mortgages and in doing so have taken part in a number of industry initiatives whereby they have selected a few lobbying areas to focus on making change. Areas where their influence has been felt in practice is in the building of a live database for EPC certificates as the current one is static, and the work on whether stamp duty should consider the energy efficiency of the property to incentive borrowers to make energy improvements. On disclosures, disappointingly they report their finance emission per division but not for the entire book of mortgages and do not have the financed emission numbers of their new prime RMBS deal. However, in the future they are looking to breakdown the financed emission into more sectors within motor, mortgages and commercial banking sectors – we have emphasised that this is something that is important and would be very useful for us. Similar to peers they are using the PCAF methodology to calculate the financed emission which is based on EPC ratings. For properties that do not have an EPC rating, they are taking the average of B to G (excluding EPC of A as they assume these would be old properties). After focussing on initiatives on mortgages as it represents the largest part of what they do, they have been exploring options for the agricultural sector and CRE lending. The main challenges in the agricultural sector are that the industry is a fragmented, highly subsidised industry with high costs associated to the climate transition. Lloyds has therefore entered into a partnership with a solar company which looks to provide financing to improve the biodiversity and climate profile for farmers, in addition to discussions with the government to provide incentives.
Very comprehensive response from Lloyds. We will continue to monitor ESG developments and whether they are meeting their targets in terms of carbon emission reduction. Importantly, maintain engagement to monitor progress on emissions disclosures for ABS deals rather than only for each lending division.
We engaged with LendInvest (the issuer) after they had sold the residual certificates in some of their deals, implying the sponsor of this UK RMBS doesn't own the rights to call its deal and relies on a third party's willingness to call its own transactions.
We organised a call to understand the rationale of these actions and assess the related risks. LendInvest sold the residual certificates in Mortimer 2021-1 in Q2 2023 to take profits and offset losses from portfolio sales as LendInvest looked to optimise its balance sheet as they under increasing financial pressure to raise capital due to rising costs of liabilities. Therefore this implies investors rely on the new owner of the call rights, which increases questions regarding a timely call given the sponsor is not involved and has current weak call incentives. In itself this doesn’t present a governance issue in our view as other structural features in the transaction could mitigate this risk. However, in this case this action comes on top of other relatively loose governance characteristics. Reassessing the governance characteristics led us to conclude the skin in the game from the sponsor would be lower and therefore the governance score would make this deal not suitable for our sustainable funds.
We sold our holdings in Mortimer 2021-1 from our sustainable funds, despite the deal meeting our minimum ESG score. Our approach to ESG means that satisfactory governance is a prerequisite for our sustainable investments.
We met with the Nationwide CFO to review their annual results and follow up on a number of environmental aspects, most importantly the verification of their net zero targets.
Nationwide expect to have their SBTi reduction targets completed before Christmas this year. They continue to engage with the government on what needs to be done to tackle UK household scope 3 emissions. On green loans, prior offerings to existing customers have failed to gain any traction, despite the favourable terms, so they have now gone one step further by offering these loans interest free up to £15,000 to help fund heat pumps, double glazing, insulation etc. The business’s social credentials continue to remain very strong in our view and this is further reinforced by the £100 member pay-out – building society profits are shared among members not shareholders.
Overall satisfactory response – the social profile remains very strong. The interest free offering is the first of its kind from the UK banking sector which is impressive. Monitor SBTi disclosures later this year.
We held a call with the company to discuss the latest developments on the ESG front given our prior engagement and concerns surrounding gas flaring.
During the first quarter, the company once again had multiple accidents at its refineries that resulted in injuries and in some cases casualties. While management is certainly focused on improving its ESG metrics and notably has now created an ESG committee, which met for the first time in March of this year to begin strategizing and tackling these problems, we believe that progress will continue to be slow and will certainly take some time for Pemex to catch up with its peers. Progress lowering emissions continues to be lacking and gas flaring issue are continuing. The company continues to lag its peers on ESG, and the lack of progress on this front continues to negatively impact the performance of the bonds in the secondary market.
Given the company's lack of progress on the ESG front and issues highlighted above, we decided to downgrade Pemex's E, S and G scores. Furthermore, we have decided to reduce our exposure to the name.
We met with the Weir Group CFO and other members of management during their recent SLB (sustainability linked bond) roadshow. Given the carbon intensive nature of the mining sector we engaged on the environmental profile of their products and the business as a whole.
While the mining sector is often viewed poorly from an environmental perspective, Wier stress that their products are both essential to the extraction of metals to support the net zero transition and that the more efficient technologies which Weir currently offer are fundamental to the decarbonisation of the mining sector. Management provided the example of their new HPGR (high pressure grinding rolls) which reduces energy consumption by 40% versus alternatives. Despite the nature of the sector they have a SBTi approved scope 1, 2 and 3 emissions reduction target; scope 1 and 2 target a 30% decline by 2030 and scope 3 targets a 15% reduction by 2030. Scope 3 emissions account for 97% of Weir’s total emissions - this is their biggest challenge in our view, they can’t control how their customers power their equipment but investing in their more efficient productions will help reduce scope 3. The company are also engaging with customers and grid operators on how they can reduce scope 3. Weir have committed to continue issuing in SLB format – this holds management accountable to their SBTi verified emissions reduction target. We did push management on being more ambitious with their 19% absolute emission reduction target by 2026 (given they are down 17% vs. 2019 baseline) however so far we believe the gains have been from the ‘low hanging fruit’ and when you include growth, the next 2% will be much more challenging.
Strong response from a business operating in a challenging sector, happy to invest in non-sustainable funds – more progress is needed on fossil fuel exposure before considering inclusion in sustainable funds.
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