Do green bonds deliver for fixed income investors?
At TwentyFour Asset Management we believe environmental, social and governance (ESG) factors can have a material influence on the value of our investments and the outcomes we achieve for our clients. In recent years many investors have begun to consider sustainability a key element of their own investment objectives, and have sought products that specifically avoid investing in companies perceived to operate in an unsustainable way.
As the popularity of these strategies has grown, however, it has become increasingly clear that there are many different interpretations of these terms across the asset management industry, and indeed in society at large. At TwentyFour, we consider investor choice to be a critical component of our ESG and sustainable fixed income solutions, which is why we offer two distinct approaches.
First, our firm-wide ESG integration framework ensures ESG risks are a factor in every investment decision our portfolio managers make, across every one of the firm’s strategies. For investors that wish to go further, we have developed sustainable funds tailored to the specific challenges of the bond markets, using a careful mix of positive and negative screening that seeks to purposely reward companies for doing the right things. With this ESG integration in place, we are able to offer investors separate funds with stated sustainability criteria.
These funds deploy a negative screen that rules out all the sectors investors concerned with sustainability would expect – alcohol, tobacco, gambling and so on – but then crucially add a positive screen for a minimum threshold ESG score, meaning companies are purposely rewarded for doing the right things. Our research has shown that this careful mix of positive and negative screens, which we have tailored to the specific challenges of sustainable investing in fixed income, enables us to optimise the funds risk adjusted returns.
At TwentyFour, we believe a truly sustainable approach to bond investing requires active management. Here are five reasons why.
ESG data in the fixed income space is often limited and typically covers only up to 60% of the investable universe, so index construction can be difficult and unreliable. Active managers are able to fill this data gap through rigorous in-house research.
Different ESG data providers often award the same company vastly different ESG scores based on the issues they consider material. For example, Tesla typically gets a high environmental score for its work on electric vehicles but is given a low governance score and marked down for toxic material mining practices. So is it a good or bad ESG investment? That will depend heavily on the data provider, and what weighting their scoring process gives to the E versus the G.
Active research takes into account qualitative metrics such as controversies, which rules-based models often struggle to pick up. Even when they do, what some of these models consider material may not be a negative issue. For example, the Asset4 model considers acquisitions a ‘controversy’, something the TwentyFour portfolio management team may disagree with in certain circumstances, since acquisitions are not inherently negative to bondholders and as such should be judged on a case by case basis.
Passive funds can become forced buyers when an index is rebalanced, and conversely cannot sell out of a company that is in the index. As a result, engagement that will actually drive change is difficult or impossible.
Passive investing doesn’t take into account momentum, i.e. a company’s movement in the direction of positive or negative change. Negative screening rules can work in some circumstances, but the role of sustainable investing is also to push for better ESG outcomes, for which an active approach is far better suited.
Chair of ESG Steering Group