Fixed income investors increasingly desire their investments to have a positive societal impact, but in the rush to scrutinise the Environmental, Social and Governance (ESG) credentials of government and corporate bond issuers, we believe the natural ESG advantages of asset-backed securities (ABS) have so far been overlooked.
Why European ABS for ESG?
European ABS can be a compelling alternative to more mainstream markets for pension funds, typically offering a spread premium over similarly rated corporate bonds and a range of investor protections adding to what we see as an attractive risk profile. But several features of ABS may also make the asset class a natural home for investors with an ESG or sustainability focus.
- Ring-fenced funding – ABS gives investors a clear link between the capital they provide and how issuers use the proceeds. ABS transactions fund a specified pool of assets, such as residential mortgages or consumer loans, and issuers cannot divert funds toward other uses. It is very difficult for companies, banks and governments to ring-fence green or sustainable funding in this manner.
- Low exposure – most sectors of the European ABS market have zero exposure to so-called ‘sin’ industries such as fossil fuels, tobacco and alcohol. In rare instances where loans to companies with lower ESG credentials may be included, these can be easily identified and avoided.
- Data transparency – ABS investors have access to details of every loan in the asset pool on a line-by-line basis, allowing for easy evaluation of quantifiable ESG factors on an ongoing basis.
- Alignment of interests – European regulators require ABS issuers to retain a minimum level of the risk in their transactions, which helps promote good governance by aligning their interest with those of investors.
- Track record – European ABS, of which the UK market is the biggest component, has historically benefitted from stricter regulation and stronger lending standards than its US counterpart, helping it avoid historical ESG issues such as the predatory lending and lack of issuer risk retention seen in the US sub-prime market prior to the global financial crisis.
In short, many of the usual ESG risks investors look for in relation to corporate and government bonds are not present in European ABS.
TwentyFour’s active approach to ESG
For true ESG integration we believe portfolio managers must do their own ESG analysis, rather than rely solely on external ESG data or a standalone team within the business.
Every day TwentyFour portfolio managers use a purpose-built relative value tool called Observatory to select bonds, and our ESG scoring is built right into this software alongside more familiar metrics such as yield and maturity. The TwentyFour ESG score is therefore a unique measure derived from a combination of third-party data and our own analysis, a method which can be time-consuming but we believe critical in giving clients the clarity they need.
In our view this active approach to assessing ESG risks is particularly important in ABS, which is not currently covered by commercial ESG data providers, making it essential for investors to have their own robust methodology. At TwentyFour, monitoring and engagement with ABS issuers on topics such as data transparency and responsible lending has been a core part of our due diligence process since the firm was founded.
Expertise and experience
TwentyFour’s investment team is one of the European ABS market’s most experienced, with a strong track record of pushing for higher standards for both issuers and investors.
Our unique ESG integration model – built on proprietary research and software – allows us to offer sustainable funds designed to meet strict goals without compromising on the potential for attractive returns, as well as tailoring our ESG screening process to investor requirements in segregated mandates.