Actively incorporating ESG analysis as part of high yield credit analysis provides an additional level of scrutiny and can potentially increase the likelihood of generating attractive risk returns while increasing protection to the downside
ESG in fixed income markets
Environmental, social and governance (ESG) investing has for some time been shrouded in misconceptions.
It is often viewed rather simplistically as the exclusive domain of the equity investor, perhaps because it is thought that it is only they who have the ability to exert influence on the companies in which they invest. Alternatively, some believe that it is not an approach for the serious investor, being only suitable for those interested in reflecting their values over and above (or even at the expense of) value creation and performance.
We would wholeheartedly dismiss both these statements. BlueBay firmly believes investing in a manner which incorporates ESG related considerations at its core has a crucial and growing role to play in fixed income markets generally, and in global high yield markets in particular. Likewise we believe this approach is integral to creating value and can sit harmoniously with a values-based approach.
Although we consider ESG investing to be a suitable strategy for the wider fixed income market (although approaches which work best here may differ to that for equity investing), we believe ESG investing is particularly well suited to the high yield bond market given the higher risk profiles of investments and specifically the approach that we at BlueBay take in managing investments within this asset class.
Minimising downside is key to long-terms success in high yield
We believe the long-term determinant of success to investing in leveraged (sub-investment grade) credit markets is an investor’s ability to minimise downside risk and preserve invested capital. Ultimately this is achieved by investing in companies where we consider the risks to the company’s ability to cover its obligations are low and are appropriately rewarded.
It is in our analysis of these risks where ESG factors are integrated into our process and playing an important role in the consideration of the credit worthiness of the issuer. Companies engaging in contentious business activities and/or irresponsible practices, or indeed where we believe the governance of the company is called into question, have the potential to be more susceptible to negative events, which may result in increased price volatility and pose credit downgrade or default risks. We find that explicit ESG analysis provides a complementary filter for identifying quality companies and that these factors are a key consideration when we deliberate the issues that may challenge long-term capital preservation.
The longer term investment timeframe of ESG investing also fits with BlueBay’s approach to investing in high yield with emphasis on core investments we seek to hold over a longer period of time, and opportunistic positions to a lesser extent,
In summary, we believe that there is the potential for both value preservation and long-term value creation as a result of considering ESG factors in our investment decision making process. Combining this integrated ESG credit analysis with product (producers of controversial weapons, tobacco and coal) and conduct (serious violation of human rights, environmental damage, corruption) based exclusions, and a level of engagement to better understand and influence corporate behaviour, provides what we believe to be a compelling investment strategy consistent with both a value and values-based outcome.