The words Environmental, Social and Governance have become commonplace in the lexicon of investors of late. Though the ESG spotlight often falls on equity investors, the consideration of ESG factors is equally paramount in the world of fixed income, both from an investor and an issuer’s point of view. As one of the largest managers of fixed income in the country, Fiera Capital’s Integrated Fixed Income (IFI) team carries significant weight in terms of influencing an issuer’s funding costs and promoting alignment with sustainable initiatives. We can therefore be an agent of change for the industry, and as such, we take it upon ourselves to consider ESG factors in all aspects of our investment process. 

Despite the popularity of ESG investing, fixed income investors have little clarity around how it actually takes place in their portfolios. We propose that there are three elements to the proper incorporation of ESG factors into fixed income portfolios: Integration; Engagement; and Reporting. Below, we discuss how the IFI team leverages this model to make ESG analysis part and parcel of the investment process. 

Integration

The first element is that ESG analysis must not be considered an afterthought – it must be fully integrated in the investment decision-making process from start to finish. The objective of active management is to form a differentiated view relative to market consensus and select candidates to over- and under-weight to materialize this view. A holistic due diligence process which integrates ESG factors dives deeper into elements that have the potential to influence a company’s financial performance. We thus must identify which, if any, ESG factors may have a material positive or negative impact on a company and determine if the compensation is commensurate with the risk. By digging deeper, a competitive edge can be gained through a better understanding of how traditional financial and non-traditional non-financial factors can influence a company’s costs, risks, opportunities and competitive advantages. Therefore, in every company research report produced, we include a formal ESG section highlighting both positive and negative ESG aspects that our credit analysis has identified. The results of this analysis feed directly into the valuation conclusion. 

The proper integration of ESG factors within an investment process becomes even more important as one considers the myriad of ESG data providers offering their services, each with a proprietary ranking model. Though the emergence of these data providers is certainly a step in the right direction, there is a lack of standardization and data gaps of issuers not captured, which can often complicate – rather than simplify – ESG consideration into the research process. Third-party scoring systems essentially combine various sources of public raw data, such as employee turnover, carbon emissions, workplace injury rates and controversies to name a few – although quite comprehensive and easily consumable by end users, this methodology may not capture nuanced factors that have the potential to influence a company’s ESG profile, necessitating a more thoughtful approach. 

We believe that though these data providers certainly have their place in the investment decision-making process, they should be a complement to in-house ESG research, rather than being used as a base. In the integration of ESG factor inputs, seasoned credit analysts with strong issuer awareness and sector expertise are best-positioned to determine the materiality of these factors and assess how much they may affect a company’s ability to pay its obligations, potentially modifying the required yield compensation we would seek. Diving deeper to uncover information that’s not readily available and scrutinizing that information to determine what it means for the financial performance of a company is the fundamental purpose of a bottom-up credit research process. The philosophy is the same for ESG analysis – it takes a deep understanding of an industry and a company to form a proper opinion.

Integrating ESG factors directly into the analysis means spending the time and resources to assure proper sector coverage and scrutinization of outside ESG data, but our team is confident that the benefits far exceed the costs.

Engagement

Given our size in the industry, we are fortunate that when we call corporate management teams, they answer the phone. We can shamelessly say that we take advantage of this in order to engage with our portfolio companies (and potential portfolio companies) as often as possible. Direct and regular engagement with issuers helps to gain greater clarity on management and learn about how they intend to mitigate ESG-related risks that have been identified by our team’s credit analysis. Publicly available data provides a sufficient picture at a point in time and captures what has already occurred, but we are less interested in what has happened, and more interested in what may happen in the future. A holistic forward assessment is possible only with a dedicated credit analysis team that is constantly engaging with companies – asking pointed questions to company management teams and gauging their answers. This is made possible only if a team has sufficient resources, people and data to effectively identify areas of concern and engage on important ESG topics. 

Importantly, this engagement with companies must be a two-way street. While they do feed us with ESG information that helps us make investment decisions, we also feed them knowledge of what the Street would like to see in terms of their ESG philosophy. That is, we affect change by identifying opportunities to engage with a company’s management and put forth recommendations for them to consider or adopt that would better align with investor interests. This engagement should lead to the company’s bond issues becoming more amenable to large investors who consider ESG in their investment process and result in a more favourable cost of capital for the company. It is not rare to have issuers reach out to us to discuss potential ESG issues, asking for advice on how they can manage it and improve their practices to alleviate any potential investor concerns. By engaging with companies, we thus garner more information which informs our decision-making process, while also helping to improve their ESG practices: a win-win situation. 

For example, at the height of the Covid-19 pandemic, we identified sectors that were expected to be most impacted. Within the highly-impacted sectors, such as oil & gas, autos, travel and real estate, our team identified issuers most at risk and began engaging with management teams to understand how they were managing and mitigating risks. One example of frequent engagement is with a leading owner and operator of seniors residences in Canada, whose tenant base primarily consisted of long-term care and retirement residences, one of the most at-risk demographics. Our goal was to obtain regular business updates and get more disclosure on Covid-19 related impacts on their operations, as well as to review ESG risks related to the pandemic. We focused on the health and well-being of tenants and staff, as well as potential financial risks. 

During meetings with company management, we advocated for performance transparency of its facilities, as well as management’s response to the pandemic, while ensuring the company was taking all necessary steps to protect its tenants and staff from virus spread within its facilities. As a result, the company has continued to improve its disclosures and provide key updates to all stakeholders, including now-daily updates on each of its properties, which helps to better track the progress and more readily identify areas of concern before they materialize into larger financial and societal risks. Furthermore, the company has also hired additional health-care experts and increased communications with residents and their families. Given the severity of Covid-19 on the company’s business model, we are pleased with the company’s actions to address such a challenge while maintaining a solid credit profile. 

Finally, it’s critical that engagement not be an isolated event prompted by a new issuance or refunding of existing debt. The conversations between analyst and management should be ongoing and documented accordingly
to track the company’s progress towards sustainability initiatives.

Reporting

The final key in the proper consideration of ESG factors in fixed income portfolios is the necessity of clear and accurate reporting. For ESG-aware investors focused on competitive investment returns, it is important to be able to access and understand how ESG risks are being managed within their portfolio. This data can take many forms: noting which companies were included or excluded based on positive or negative screens; analysis around which holdings are under- or overweight based on ESG risks; revealing statistics around how many ESG-related meetings a portfolio manager held with the issuers in their portfolio and what topics were discussed. These discussions and disclosures help create greater transparency for ESG-conscious investors.

Reporting is evolving beyond traditional financial metrics. Demonstrating the beneficial societal impacts is imperative, yet a comprehensive dataset remains elusive to date. Third-party ESG data for the Canadian fixed income landscape continue to be limited as coverage of many important metrics is available for less than half of the investible universe. As a potential agent of change, one goal of our team is to help enrich the data. We not only engage with companies, we also engage with third-party ESG providers to offer on-going feedback to improve coverage.

A primary reporting objective of ours is to enhance ESG performance tracking. We are working towards developing solutions to present ESG metrics benchmarked intuitively for investors. Examples include better identification of differentiating ESG factors, measuring the impact of ESG integration and comparing our funds (in which we integrate ESG factors directly into the investment process) to explicitly ESG-labeled funds (which exclude certain sectors and companies based on ESG criteria). Complete ESG data is still unavailable for many companies, making portfolio comparison difficult to date, but we are working hard to change this. With more data availability through external providers and internally-driven efforts, we expect further improvement, making reporting even more transparent for investors in the coming years.

Bottom line: holistic ESG integration to maximize outcomes 

ESG investing is not limited to ESG labelled funds. A true ESG framework must fully integrate ESG factors into every aspect of the decision-making process. The framework should start with the identification of risks tied to ESG, but it cannot end there: ongoing engagement with management teams and clear reporting to end investors are both crucial. Using this approach, we can better deliver on client investment objectives while also aligning with ESG goals.