Stockholm (NordSIP) – During a year when banks have run afoul of financial markets and policy-makers, it is understandable that most asset managers focused on that market segment are taking a more discreet stance and waiting for better days to taunt their strategies. However, not all asset managers have taken this demure approach.
Romain Miginiac (Pictured), Portfolio Manager (PM) of the GAM Sustainable Climate Bond strategy, an impact strategy, classified as Article 9 under the EU’s Sustainable Finance Disclosures Regulation (SFDR), argues that this reluctance is misplaced. According to Miginiac, green subordinated debt from financial institutions when supported by ESG-analysis allows investors to gain exposure to a wide range of impact projects across the world.
Navigating Financial Risk and ESG Concerns
For Miginiac, the way to find sustainable value in financial institutions is to invest in the green subordinated debt of ESG-committed banks and insurance companies.
“People tend to overestimate the risk of subordinated debt issued by high-quality issuers. This creates almost a market inefficiency where one can get paid more for the same credit rating and duration by investing into the subordinated debt of an investment grade financial institution compared to senior debt,” Miginiac says. “BBB-rated Tier-2 subordinated debt from a highly-rated issuer can offer 100bps or more extra yield as that of a senior bond of a BBB corporate (non-financial) bond like those of EDF. This means that investing in subordinated debt can allow investors to get an attractive pick up in yield for the tier-2 securities issued by A-rated entities compared to IG corporate bonds,” Miginiac explains.
“There is a complexity premium. Investors in a tier-2 bond are subordinated to their senior colleagues. This means that they effectively face a higher risk, since in case of a credit event, their claims will be the first to take a hit. They will be wiped out,” Miginiac warns. “However, it should also be noted that if the subordinated debt is BBB-rated, then it normally means that the issuer is A-rated. So the default risk that investors are taking on with a BBB tier 2 bond is actually lower than the risk they are taking on a BBB corporate bond. Yet investors capture higher yields on subordinated debt.”
Following the intense scrutiny faced by senior and subordinated investors in financial institutions during the first quarter of 2023, some scepticism is perhaps warranted. However, according to Miginiac, an ESG-integrated investment process can help investors avoid the dangers presented by the markets’ recent black sheep, such as Silicon Valley Bank (SVB) or Credit Suisse (CS), among others. “None of those entities would have passed our ESG selection process. CS would have struggled on governance grounds, while SVB would have struggled on a more general basis given US banks’ weaker ESG practices – especially around climate risks,” Miginiac argues.
The Lack of Appeal of Nordic Markets
One of the most interesting insights NordSIP gathered from Miginiac was his understanding of the lack of appeal of Nordic banks as investments for a sustainable asset manager focused on financial institutions. Tight spreads seem to be the main concern on this front.
“Our focus is on core Europe, i.e.: France, Netherlands, Spain, UK and Belgium. The Nordic banks screen well in terms of sustainability. However, they currently offer less attractive yields compared to other European banks. Some Nordic banks have been dealing with governance issues, while the others are either too small or priced too tightly Our sole Nordic investment is in Norway,” Miginiac says.
The issue of tight spreads appears to be a standard feature of Nordic financial markets. “Nordic economies are AAA-rated and Nordic banks typically have very strong fundamentals, hence they are seen as a safe haven in the sector. . Whether it is in green or non-green format, Nordic banks always tend to trade at tight levels of spread compared to French banks, for example,” Miginiac adds.
The Appeal of Investing in European Banks
If Nordic organisations don’t offer enough spread, their American counterparts could be said to suffer from a problem in the opposite direction. “We don’t currently have exposure to the US banks. They’re too far behind in terms of their climate integration journey vis-à-vis Europe. They would typically not pass our ESG selection process,” Miginiac continues.
“Banks in the EU are also generally more attractive than their USA counterparts from a fundamental perspective. Following the global financial crisis and sovereign debt crisis, the EU implemented stricter macro-prudential regulations across the sector – not only the large systemic banks. Hence European banks have not been hit with similar issues compared to domestic US banks. We see European banks as one of the strongest sectors from a bondholder’s perspective, very resiliently able to navigate the current period of uncertainty.,” Miginiac explains.
“More generally, one of the benefits of investing in the green bonds of financial institutions is the breadth of impact investors are exposed to – corporates, SMEs and individuals. Banks finance green projects in virtually all sectors and globally – for example, SMEs, or Emerging markets – private markets impact in highly liquid green bonds from top quality issuers. While our strategy might be focused on European financial institutions, the projects financed are well diversified across geography and sectors,” Miginiac argues. Moreover, asides from the breadth of impact gained by investing in financial institutions, GAM’s strategy also leverages issuers’ strong governance and frameworks to select green projects – for example, those in Emerging market,” Miginiac adds.
Still Some Way to Go
At a time of green hushing, it’s a relief to see that not all AMs are running for the hills. “Now is not the time to slow down in our fight against climate change. Although climate finance flows have accelerated to US$850 billion, from half that amount a decade ago, we are still falling significantly short of the US$4 trillion annual investments required by 2030 to meet the Paris Agreement targets,” Miginiac concludes.