With environmental, social and governance (ESG) factors now more broadly incorporated into investment decision making, fixed income investors are faced with the challenge of how best to implement these across such a diverse asset class.
While it is true that ESG can easily be integrated in the listed corporate credit market, the same cannot be said for structured credit, high yielding credit, distressed credit or emerging market sovereign debt. Some fixed income investors have taken the view that, where ESG is too difficult to incorporate in investment decision making, it can be ignored; we disagree. Our fixed income team believes ESG metrics can help identify risk factors and enable us to avoid the ‘potholes’, namely defaults.
The fixed income team of Momentum Investments has developed a framework that is quantitative and qualitative to assess ESG metrics across the diverse spectrum of debt instruments. Our framework has the goal of uncovering hidden strengths and vulnerabilities of issuers. Some of these vulnerabilities and strengths may not be easily uncovered if one only looked at traditional credit metrics.
Our framework first looks at qualitative factors, especially those that relate to the governance (G) factor. Several defaults that have occurred in the past few years have been because of governance failures. We believe this factor needs to be given significant attention so that, as investors, we can not only avoid ‘potholes’ but also use our power to work with issuers to make sure that sound governance, necessary for sustainability, is present. Our framework depends on our ability to have regular engagements with management of the various issuers, boards of state-owned enterprises and National Treasury. Without this ability, some of the qualitative factors we assess would not be visible to us and would make ESG integration in our investment process near impossible. We see this access as one of the strengths of being a sizeable fixed income house.
Environmental (E) factors are increasingly becoming more important. With global warming fast approaching the point of no return, we believe we need to use our power as lenders to the corporates, some of the biggest emitters of greenhouse gasses, to reach carbon neutrality over time in a sustainable way.
Our fixed income team, as a significant lender in the debt capital markets, has been working with issuers and debt arrangers on sustainability-linked debt that specifically target the ‘E’ factor. We have participated in a few issuances that penalise issuers if pre-specified environmental factors are not reached. For example, we recently participated in the Rand Water SOC Sustainability Linked Bonds, whose objective is to link the coupons we receive to Rand Water’s commitment to doing its part of implementing and achieving the United Nation’s seventh sustainable development goal (affordable and clean energy), sixth goal (clean water and sanitation) and fifth goal (gender equality). The bonds are linked to specific targets Rand Water needs to meet by 2023 and 2025. If these targets are met, there is a benefit to the company, ie reduced coupon payments. As investors, we are happy to receive reduced coupons because of the sustainability metrics that will be met. Further, to show how seriously we take environmental sustainability, we have also taken a decision that we will not fund any new coal-fired power stations.
As investors on behalf of our clients, we take responsibility to make sure we provide our clients with the best risk-adjusted returns. We also have a duty to make sure we allocate our clients’ money to investments that guarantee a sustainable future. With the recent unrest we experienced in South Africa in July 2021, it has become even more pressing to work at speed with National Treasury so debt instruments that can address social (S) factors are made available to the market. Our view has always been that, in addition to funding the sovereign through government bonds, we need other investments that can have a direct and measurable effect on people’s lives. Social impact bonds that address various social needs, where we as investors provide funding for an intervention that is responsible for the social services delivery, is what South Africa needs. Through various forums of the Association of Savings and Investment South Africa (ASISA), we are involved in discussions to help set these social impact bonds up and make sure the investments are appropriate for the client mandates we manage. We are also assessing other issuers, such as The Urban Housing Foundation, which provide affordable housing. Addressing social factors is important for the sustainability of South Africa.
ESG integration in investment decision making will help investors use their influence to ensure sustainability. ESG integration in South African fixed income investing is no longer a luxury but a must-have. As an investment manager of a large pool of retirement fund investments, we at Momentum Investments also believe it is our legal duty to consider ESG factors in our investment approach. Regulation 28 states that investment managers have to “… give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social or governance character. This concept applies across all assets and categories of assets and should promote the interests of a fund in a stable and transparent environment.”
We believe we are living this intent and building a competitive advantage in this space through the innovative efforts highlighted here.
ENDS
