This article is a part of NordSIP Insights – Handbook – “Sustainable Fixed Income – 2019”.
ESG and SDG Integration in Fixed Income
“Sustainability status does not cost investment performance,” says Guido Moret, Head of Sustainability Integration Credits at Robeco. In his presentation, sustainability expert discussed his firm’s approach to sustainability, its ESG and SDG integration methodologies and how this methodology benefits investors financially. He considered the differences between engagement in equity and in fixed income.
ESG & SDG integration – a win-win
“When considering our investments, we ask ourselves two questions: ‘How does sustainable development affect a company?’ and ‘How does a company influence sustainable development?’ To us, the first question is about ESG integration, whereas the second is about the internalisation of the SDGs into the investment process and making an impact in the world,” Moret starts.
“ESG integration follows from financial materiality. The impact side is more about norm- and ethics-based choices, as well as avoiding harm. In our research process, we express both of these notions in the form of two combined scores. We have a fundamental credit score, the ‘F-Score’, where we take ESG integration into account. Then, we also have an SDG score, which is about the alignment of company with the UN’s goals”
“These two notions of ESG integration and impact investing are related and we find that they often intersect. The way we see it, economic actors can have a negative or a positive impact on society. In the long run they will either pay for a negative impact or you will be rewarded for their positive impact. If you do good for society, in the long run, society will serve you well, financially.”
ESG integration at Robeco
“For every credit that we cover, an analyst writes a report that consists of five different components: the business position, the corporate strategy, the financial profile and the corporate structure, which are traditional dimensions; they also assess the ESG profile. These five factors combined lead to a fundamental score. The weight of each element of the score is not equal or predefined to contribute to the final score. It can be that one of them or two of them in combination have an overwhelming effect on the fundamental score,” continues Moret.
“Financial performance can be really poor, whereas the strategy is fine. The business position can be good, while the company’s financials still look very modest. The score can also be depressed by a very low fundamental score from an ESG perspective. This means that the notion of sustainability is truly integrated in the investment process given that the S-Score is also determined by the ESG components. We identify the most material topics in the industry that the issuer belongs to, and then we look at how the company is exposed to those matters. This framework informs the conversation between the analyst and the portfolio managers on how all these five components weigh into the final S-Score.”
Moret provides a numerical example: “If the S-Score is zero, it means that we haven’t identified any additional risk than we would normally expect, be it from a fundamental, financial or ESG perspective. If we are able to find an attractive spread that is higher than the average, we would conclude that this is an attractive investment opportunity. At the other end of the performance bracket, we could also find a case where everything looks fundamentally quite weak, but the spread is actually quite tight.”
“As you can see, the ESG integration components are very much about risk and financial materiality,” Moret emphasises.
Impact assessment and the SDG alignment
“On the other side we have the impact approach,” the portfolio manager explains. “We use the 17 UN SDGs to define impact. Among other strategies, we also have a fund range that only invest in companies that are aligned with these goals or at least do not contribute negatively. However, even for all the other credit strategies we manage, which are not specifically targeted at the SDGs, we still calculate the score and take it into account at the credit committee. Indeed, a lack of SDG alignment may also translate into additional risk given the circular mechanism between the goals, ESG factors and future risk.”
“Assessing SDG alignment is not easy,” Moret admits. “There are 17 goals and 169 underlying targets. Most companies will most likely have some positive contribution to some of the goals or targets. However, you may also find some negative contributions. We are left to disentangle the good from the bad. How should we weigh environmental goals against the social goals, for example? To overcome this challenge, together with RobecoSAM, we developed a framework to make choices that are consistent.”
“We have designed three steps. First, we look at the products or services that a company offers. Then we consider how a company provides these products or services and how it operates in general. Here we are talking about how the company behaves. We consider how it is managed, what are the environmental and the social management procedures of the company, what governance is like. The third step is to correct for controversies. The company may have the right policies in place, but it may all have failed or there may be issues in specific parts of the company. We need to take these issues into account. After completing these three assessments, we form a score that ranges from plus three to minus three.”
“In about 15% of the cases, an SDG score that was given from a product perspective is adjusted, either up or down, based on behaviour. When controversies arise, such as spills, accounting fraud, bribery and child labour, the SDG score will be downgraded to a negative.
“The final SDG score is not ‘netted’. If a company does well on one issue and poorly in another, we do not net the positive factor with the negative one to obtain a result of zero. Instead, if we have established that a company contributes negatively to SDGs the final score is negative. The negative will overrule the positive. This conclusion stems from a principle that we want to do no harm with this fund range, above all else, and therefore invest only in those companies that are at least neutral in terms of SDG contribution. And therefore, by neutral we do not mean ‘net neutral’, but we do allow those companies in that may currently not generate any positive impact, as long as we exclude all the companies that have a negative contribution,” Moret specifies.
“Every analyst is able to and is responsible to analyse the SDG score of all their companies. They follow the framework, and they know exactly what the KPIs are for their own sector. Over time, we have been able to show that SDG integration matters. In a preliminary study, we found a statistically significant difference between the sectors with several negative SDG scores and those with a high number of positive ones. ‘Positive’ sectors exhibit lower rates, higher returns and experience less downgrades and more upgrades than the ‘negative’ ones. Being sustainable has definitely no cost.”
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