As an organisation, we believe that considering long-term environmental, social and governance (ESG) factors alongside financial factors supports both our clients’ goals and our corporate goals. For fixed income, our ESG assessment sits alongside our traditional credit analysis, which identifies and assesses the risks that feed into the investment decision. Our decision to invest or not is based on a financial analysis and an assessment of ESG factors. We seek robust companies that can provide sufficient investment returns and cash flows through market fluctuations and changes in ESG sentiments.
While we consider ESG risks holistically in our investment decisions, we also assess E, S and G risks as individual strands in bottom-up analysis. For the environmental factors, we emphasise climate change, focusing on carbon emissions generated by the counterparty directly or indirectly through its products and services. For social factors, we focus on identifiable actions that companies are taking to be good corporate citizens. For governance factors, we focus on the integrity of the board and management, minority stakeholders’ rights and the transparency of financial reporting.
Our fixed income credit analysts know and understand the companies we invest in, so they take responsibility for considering both the financial and the ESG issues that affect these companies. This promotes a holistic approach, whereby a single analyst develops a complete picture of a specific company.
Governance
Our approach to investing in short-dated fixed income funds, particularly in money markets, has a significant overlap with this approach, especially the governance element as, among other objectives, it focuses on delivering capital preservation and sustainable returns. Within our short-dated fixed income funds, this scrutiny of our counterparties’ governance and creditworthiness is even more critical to success.
Clearly, unlike equity investors, bond holders do not have the same voting opportunities on governance issues. We must demonstrate good stewardship before investing, through due diligence and other activities that allow us to engage with bond issuers.
For our funds that hold a range of money market instruments, bank paper represents a large proportion of the assets. Therefore, monitoring bank stability – especially in the new higher interest-rate environment – is central to these funds’ approach. Events this year, which saw a number of high-profile bank collapses, including Credit Suisse and Silicon Valley Bank, have brought bank governance back into sharp focus. Higher rates will likely have an increasing impact on finances and possibly bank profitability and stability.
Through our ongoing monitoring of counterparty banks and prior to that, careful analysis of potential counterparties, should protect these funds. We may also exclude specific bank counterparties for broader governance and social issues, and several high-profile banks have previously been removed from our portfolios for such issues.
Investment approach
This is part of our broader investment approach to short-dated fixed income funds, where we apply stringent credit requirements, given the risks that a credit default could pose to fund liquidity. In order for a name to be included in our counterparty list, we must be satisfied that they have strong fundamentals. Assets will be bought on a risk-return basis looking at ratings, internal analysts’ outlook, existing exposure, liquidity of counterparty and comparable returns.
Prior to investment in new issuers, we engage with our independent credit research team. The liquidity investment team maintains a collaborative relationship with the credit research team and meets with it regularly to review the approved counterparties for potential concerns and reflect this in our decision-making. The internal credit ratings, supplementary to the external credit ratings, produced by our analysts add an additional level of scrutiny to our investments. We use this internal research to select securities that we believe offer the best balance of risk and return.
This is part of the wider investment decision-making process whereby the investment team meets regularly with colleagues from around the business to discuss market conditions, fixedincome fund reviews, ratings reviews, liquidity counterparty reviews, ESG reviews. Combined with market data, these meetings give a balanced view of market expectations and support investment decisions within the fund.
Environmental and social considerations
For short-dated fixed income funds, negative screening excludes issuers that derive more than 10% of their revenue from either one, or a combination of the following unless in a specific green bond: tobacco, controversial weapons, fossil fuels, tar/oil sands and thermal coal (extraction, production or distribution).
However, we find many of the counterparties that these ESG screens would exclude from our universe have already been ruled out during credit screening. Our focus on strong fundamentals means we consider only assets with the highest credit ratings, illustrating how often the ESG risks and financial risks overlap. For those that would meet the credit criteria some, for example certain energy companies, have been removed until such a time that their environmental credentials improve.
Conclusion
Both within our liquidity portfolios and more broadly across the investment business we consider the potential impact of environmental risks across our portfolios and seek to encourage high standards of governance and social responsibility. By integrating ESG metrics and qualitative considerations alongside our financial analysis into our investment processes, and by pursuing constructive engagement with companies in which we invest, we aim to achieve optimal investment outcomes for our clients, society and our business.
Steve Matthews is a fund manager, liquidity, at Canada Life Asset Management
Charity Finance wishes to thank Canada Life for its support with this article
