Different interpretations and scoring
The other inevitable aspect of trying to quantify subjective factors (after all, ESG will mean different things to many different people) is that there is very little consistency across various ESG ratings agencies. This isn’t necessarily a problem. But these studies do serve to highlight that no-one (ourselves or fund selectors) should rely wholly on one source of ESG information.
So what does this all mean in practice? Is it possible to integrate ESG into fixed income investing? We believe so. But it is not by trying to engineer a fund to have a good overall ESG rating. As a side note, the ESG ratings agencies typically have a very small number of very badly rated and very well rated companies. In reality, this means that a fund could easily engineer a good ESG score by avoiding/gaining exposure to one or two companies. In other words, a very small number of holdings could distort the fund’s ESG rating. This is especially true for more concentrated funds.
Manifest truths are still the strongest indicator
Rather, the way we prefer to look at ESG is by applying good old fundamental analysis and integrating ESG factors, as opposed to overlaying them on top of a fund. Instead of looking at how many policies a company has, we prefer to focus on where poor business practices or exploitative social and environmental activities could threaten sustainability of cashflow. Instead of looking at whether a company is a signatory to a particular initiative, we prefer to look at which technologies and developments risk making certain sectors redundant. Instead of looking at whether a company has an explicit policy on energy use, we prefer to look at how much carbon emission it emits – and more importantly the trajectory of such emissions and whether these could threaten the sustainability of cashflow further down the line.
ESG as one of many factors
The other thing worth keeping in mind is that, by their nature, bonds most often have a maturity date. Investing in an auto company for the next 30 years is very different to investing in it for the next five. As such, we are not in favour of having an exclusive policy which would leave the fund constrained. Instead, we prefer to take a pragmatic approach and consider ESG and financial factors to be intermingled. In the same way that we would not exclude a company from our investing universe on the basis of a financial metric, we would not exclude a bond from our investment universe because it has a bad ESG rating. Rather, we ask ourselves if we are being compensated for the risks that a particular bond carries, whether they may be of a financial or an ESG nature.
