Sustainable Business | May 01, 2019 | Gabelli School of Business
ESG Ratings for Fixed Income Securities
The widespread concern about climate change and discussions about corporate social responsibility (CSR) have created a new mantra in investing: “Doing well by doing good.” This same emphasis on sustainability and CSR is encoded in the UN’s seven principles of responsible investment (PRI) and the UN’s 17 sustainable development goals (SDG), and investors are responding.
According to the US SIF Foundation (SIF), some $12 trillion in assets under management are already sourced from sustainable strategies in the U.S. alone.
The demand for sustainable and socially responsible investment is showing itself most prominently from millennials who are enjoying the largest generational transfer of wealth, and who will make many of the most influential investment decisions in the years ahead. As they enter the investment space, they are leading the way among others who wish to make significant investments in social good.
As a response, institutional investors have adopted various methods and strategies to meet investor needs, including systematic ways to evaluate the environmental, social and governance (ESG) criteria for large publicly traded companies—an approach commonly referred to as ESG integration. From MSCI to Bloomberg to Yahoo Finance, there are many sources for ESG data on many companies. This data has been used to evaluate investment in equities or equity mutual funds but, still, there has been relatively little discussion of ESG integration for investing in bonds.
On April 11, the Fixed Income Analysts Society, Inc. (FIASI), in partnership with Fordham’s Gabelli Center for Global Security Analysis, took a step in exploring this important and evolving area, hosting “ESG Integration in Fixed Income,” addressing the fastest growing segment within the sustainable asset class.
ESG Just Like Any Other Material Information
Henry Shilling, FIASI board member and director of research at Sustainable Research and Analysis LLC, opened the symposium and defined the scope for sustainable investing generally and ESG integration in fixed income space in particular, emphasizing the importance of ESG integration in risk mitigation.
Shilling presented two ways to express the magnitude of ESG integration. On the one hand, a current examination of mutual fund an exchange-traded fund assets in the U.S. shows that $627 billion in assets were sourced to sustainable investing – 2.2% of the long-term mutual fund and ETF asset class. But data collected by the US SIF Foundation shows that roughly one in four dollars of about $47 trillion is sourced to sustainable strategies. “Regardless of where the true number lies, sustainable investing strategies are gaining traction in the U.S. and also overseas in Europe, Asia and Latin America,” Shilling said.
Robert Kricheff, of Shenkman Asset Management, commented, “We view ESG as a tool that has to be integrated into financial objectives because of the financial risks that it could create for a company,” Kricheff said. “Every piece of research I’ve read that’s done by someone who could benefit from more ESG factors and sustainability factors has shown that you do better using those.”
Sris Chatterjee, Gabelli Chair in Global Security Analysis at Fordham University, then provided a brief background for the audience and a framework for the panel discussions. He underscored some of the added complexities for the fixed income world in comparison to investing in equities. “If I want to invest in the common stock of a company that is strong in CSR and ESG, then I am looking at only one security – or may be two, in case the company has two types of common stock. Still, it is much harder when it comes to fixed income because the company may have many fixed income instruments outstanding, that differ in lots of different aspects of their contracts and competitive features. Not all bonds of a company have equal ESG-related risk. The selection problem is more challenging.”
Chatterjee also talked about the need for adopting a uniform standard for evaluating ESG ratings. He spoke about a homework assignment he gives to his students, asking them to look at Barron’s annual list of the top 100 CSR companies and compare their sustainability scores to the scores published in Yahoo Finance and Bloomberg. One would expect the correlation to be high, but the correlation is sometimes as low as 10%, he said.
Thomas Kuh, Ph.D., Head of Index at Truvalue labs, underlined some of these issues in his keynote speech. Some large institutions already offer investors more than 100 products related to social and environmental criteria. The asset class has grown quickly, but there has yet to be agreement on whether the outcome of ESG analysis should be called scores, ratings or assessments.
“There seems to be no acceptable standard among different sized firms,” Kuh said.
Kathleen Bochman, of Loomis Sayles, Matt Daly, of Conning, and Thomas Socha, of JP Morgan Asset Management, spoke on a panel about ESG integration in investment grade fixed income. Later in the afternoon, Andrew Steel, of Fitch Ratings, James Hempstead, of Moody’s Investors Service, and Lisa Schroeer, of S&P Global, participated in a panel on how the rating agencies were incorporating the ESG data in their rating methodologies.
They shared that each agency had developed its own unique way to process the vast amount of ESG data, and that ESG evaluation methods are contributing to an analytical renaissance, with institutions and investors having access to deeper and more uniform sets of data helping to minimize risk and achieve gains.
Too Soon for the Greenium?
In the end, as one member from the audience asked, can we reach a point or create a model which allows us to calibrate the ESG score into a quantitative risk premium? The idea of a risk premium, referred to as the Greenium by industry experts, would allow investors to explicitly factor the ESG risk into the price of a security issued by a firm.
The structure of fixed income makes it more difficult than equities to integrate ESG factors, but as ESG evaluation becomes more of a household term, Kricheff, Joshua Linder of APG Asset Management US, and Kristal Yee Seales of TIAA Investments, predicted a smarter investor base seeking out specific ESG requirements, and even an evaluation system that measures actual ESG impact.
“Still, it’s too early for the Greenium,” Linder said, referring to the point when investors would explicitly be willing to trade wealth for societal benefits.