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Why fixed-income investors should factor sustainability into investment decisions

Why should fixed-income investors factor sustainability into their investment decisions, and what are the approaches available to them? What drives an impactful engagement with a credit issuer? These are some of the key questions that our clients and prospective investors ask about ESG and engagement in fixed-income markets.

Here Mitch Reznick, Head of Research and Sustainable Fixed Income, and Aaron Hay, Lead Engager for Fixed Income, provide the answers. 

Reznick: Basically, sustainable investing has two objectives. Firstly, a return on investment, which is fairly typical. But the second objective is an extension of that - investing not only to seek returns from the investment, but also seeking a return through society. Sustainable investing has been around for years but has recently gained momentum – partly due to the well-publicised effects of climate change. So, there’s a real focus on these kinds of issues at the moment.

In terms of defining different types of sustainable investing, we can break them down into broadly three categories. ESG integration, thematic, and impact investing. ESG integration is mainstream investing at Hermes, where we assess and price the materiality, probability and timing of non-fundamental factors, environmental and social governance issues.

The second, thematic, is when investors want more of a tilt in their investment style towards the sustainability theme. So, for example, exclusions to certain sectors like coal or tobacco. And third, impact, is where an investor can really have a constructive impact, or voice, in how a company is run. With impact investing, you can change the way a company behaves, to truly create positive change to the environment or society.

Hay: Effectively, we engage companies on environmental, social and governance issues. Increasingly over the last few years this has involved engaging on strategy and risk issues as well.  The way that we do this at Hermes is a bit unique because we have our own stewardship engagement business, Hermes EOS.

Hermes EOS is one of the tremendous assets that allow us to deliver a unique engagement capacity.  It has a team of about 30 people, advising on around £634bn of assets1 for around 45-50 external clients.  And these companies, pension funds and long-term asset owners have entrusted us to engage and steward these companies on their behalf.

To give you an example of this, we do a lot of very intensive engagement in automotive value chains and energy value chains and increasingly the social and the environmental issues that are affecting these sectors.  This is everything from workforce stoppages to these companies’ commitments to climate change.  We have the expertise and the engagement capability of our EOS team to be able to directly engage with these companies on these issues and we have the insight and the capacity and capability of our investment teams to understand how the company is performing relative to those issues, as well as on a financial basis.

Hay: The ability to influence and change companies from within, where you have a real and legitimate seat at the table, where you can ask for change – that really appealed to me. I was so pleased and surprised in my first couple of months to see how influential EOS can be, and how much companies sit up and listen when you say I’m here on behalf of 2% of your investors.

Reznick: Going back to thematic versus impact investing, if you exclude part of a portfolio and an investor can’t invest in that portfolio, then one could say that you are reducing the amount of return.  And I think that that was one of the challenges that ESG advocates faced a few years ago.  But now that we’ve seen the power of ESG integration and engagement, and how they can enhance returns, we are finally in a position to be able to push back and say ESG does not take returns away.

Reznick: We were so frustrated by the lack of research on assessing and pricing credit risk in the ESG space, that we created our own tools. We conducted a quantitative study on attaching ESG factors to credit risk and discovered firstly, that there is a relationship between ESG risks and credit spreads.  The higher the risk, the wider the spreads, and the reverse is also true.  And secondly, that it was not entirely explained by credit ratings.  So, we went on to draw ourselves an ESG credit curve – an implied credit curve based on the level of QESG scores and where the credit curves lie.  And that’s been an important, and I’d say pioneering, step in terms of trying to attach ESG factors along with returns in credit (Read our research here). 

Hay: I’ve never had that reaction from any company.  I’ve certainly had a few doors that have been opened and then there’s been a disinterested conversation, but I think that’s extremely rare.  We have a unique position with Hermes EOS: as it has such a large amount of assets under advice level, we are able to tell companies about some of the investors that we are representing and that gets their attention very quickly.

But I think moving to the next level where it becomes a two-way dialogue, companies will be more open, more frank.  They will be more likely to take on advice.  That only comes with credibility and quite frankly, developing a relationship, which takes time.

Don't forget to tune in to Delta

This two-part episode of Delta explores home territory for Hermes that is of keen interest for many investors that we speak with: the purpose and practice of environmental, social and governance (ESG) analysis and corporate engagement in fixed-income markets.

In part I, Andrew ‘Jacko’ Jackson, Head of Fixed Income, and Mitch Reznick, Head of Research and Sustainable Fixed Income, discuss how ESG-investment strategies ranging from integration to impact apply to fixed-income markets. Aaron Hay, an engager in the fixed-income team, then explains what is required for an engagement with a company to be successful.

Step into our world. Listen to Delta. 

  1. 1As at 30 September 2019. See for more information.
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  • The views and opinions contained herein are those of Mitch Reznick, Head of Research and Sustainable Fixed Income, and Aaron Hay, Lead Engager for Fixed Income, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products.
  • This information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
  • The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.
  • Past performance is not a reliable indicator of future results.