by Carl Berthold, JAR Capital
Bond investors lend countries or companies money for a limited period of time for a specific interest rate that is acceptable to both parties at issue. Unlike equity investors, they acquire no ownership. Typically, these investors have no voting rights, do not attend shareholder meetings and have much less influence on business decisions. This has led to the perception that bond holders have no influence on companies. The truth is rather different, especially in the high yield bond market. Lower rated high yield companies have, generally speaking, one thing in common – a need for continued external financing to pursue their business plan. As such, management of these companies must actively attract investors and so bond investors have the opportunity to engage with companies at management level and pursue their investment goals according to their chosen method.
Increasingly, these methods factor in ESG criteria, a fact that seems to be unknown to many bond issuing companies in the high yield market. For example, over 1,900 signatories representing around USD 80 trillion of assets have signed up to abide by the United Nations’ Principles for Responsible Investment (UNPRI). It should be in the vital interest of any borrower which depends on capital from global investors such as these signatories to ensure that no avoidable obstacles exist precluding investment.
Increasingly often, investors have the mandate or fiduciary duty to invest taking ESG criteria into account. This might arise out of ethical and/or economic considerations. In addition, a growing number of countries are introducing regulation requiring public pension funds to take ESG criteria in their investment making decisions into account. For example, the EU commission’s legislative proposals on sustainable finance will require disclosure requirements on how institutional investors integrate ESG factors in their risk processes. At the moment, companies often seem to be unaware of the new EU Accounting Directive (2014/95/EU) requiring them to disclose non-financial and diversity information in their annual reports from 2018 onwards. Regardless of bondholders’ or equity holders’ requests companies will have to deal with ESG criteria, especially if they are publicly traded or wish to IPO at some point in the future.
As a portfolio manager, JAR Capital has always considered sustainability criteria to be an additional and indispensable risk management tool which helps us to analyse companies and to better understand their full risk profile. In our opinion these criteria naturally have to include, among other factors, transparency, corporate governance, reputational, environmental and litigation risks. In fact, these criteria have always been part of the due diligence process but we have now ‘professionalised’ them by employing ESG experts to be involved with the analysis allowing us to continue to focus on the quantitative and qualitative analysis of companies. As such, ESG assessment represents a natural extension of the risk management process. We believe credit investing is all about minimising downside risk and, therefore, any tool that helps us in achieving this is welcome.
To date, no sustainability rating agency has rated the high yield universe. It is thus impossible to differentiate and manage according to best-in-class criteria which is available to equity or investment grade investors. JAR Capital, together with its co-operation partners, is pioneering the concept by building up a rated universe and working together with the companies to improve their ESG rating over time. For the rating analysis we chose ISS-oekom, one of the largest independent rating agencies in the sustainable space, which has been operating since 1993 and employs more than 1,200 highly qualified experts. On behalf of JAR Capital ISS-oekom analyses and rates JAR Capital’s investment universe periodically on the basis of up to 100 rating criteria. Analysts gather information through media and other public sources, conduct interviews with stakeholders, and collect information on company policies and practices. Extensive company and stakeholder dialogue, coupled with strict verification, ensures objective and in-depth research.
Given the novelty of ESG analysis for many companies in the high yield market, the initial ISS-oekom rating is rarely in, or close to, the prime or best-in-class category. Information is simply not available or presented. JAR Capital’s solution is to work additionally with an engagement specialist which addresses the identified weaknesses from the initial ISS-oekom rating report at management level.
Where required, JAR Capital functions as the door opener to the companies and facilitates the dialogue with the engagement company. The engagement with every single portfolio company enables us to be closer to management and enhance transparency at many different levels. It defines the change objective clearly, not only to resolve the immediate problem, but to improve ESG preparedness of the company. Furthermore, it defines the strategy for change, establishes a constructive relationship and a two-way engagement dialogue with a clear time frame. A range of appropriate tools is applied including mail dialogue, calls, meetings, conference calls and site visits. Where possible, we seek to work on a collaborative basis to leverage the power of influence. We truly believe the engagement dialogue substantially benefits the analysed companies as well as us and provides them clear incentive to improve their ESG credentials over time.
Ideally, integrating sustainability criteria into our investment process will help us achieve our paramount objectives: fulfilling our fiduciary mandate toward our investors and maintaining our track record of no defaults in any of our funds.
This article is part of the NordSIP Handbook on Sustainable Fixed Income that you can find here.
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