We sat down for an exclusive interview with Francis Menassa, JAR Capital.
As European legislation includes more ESG (Environmental, Social, and Governance) or sustainable factors and there is an increasing number of funds on offer, the trend is set to continue. Even a recent World Bank report stated that incorporating ESG into fixed income investments should be part of the overall credit risk analysis and should contribute to more stable financial returns.
Yet, Francis Menassa, Principal, JAR Capital believes that assessing environmental, social and governance factors in fixed income investing is nothing new. Here he answers some key questions about the state of ESG investing in 2019 and tells us a bit about his experience investing in the sector.
Interest in fixed income ESG is gathering momentum: why now?
So far in 2019, we are seeing a major push for ESG investing strategies. In fact, in the last two years investing in ESG fixed income has increased 34% and now accounts for over a third of responsible investing, according to the Global Sustainable Investment Alliance. In Scandinavia, Holland and France, many fund groups incorporate sustainability at the heart of their investing strategy, and there are a growing number of family offices in the US that are switching to sustainability.
The particular interest in fixed income is partly because there have been a number of industry-wide approaches and some major policy developments which are now beginning to take effect.
For example, the EU’s 2014 Non-Financial Reporting Directive which was fully implemented at the end of 2017. It will apply to every country on a national level to implement and requires large companies to disclose non-financial and diversity information. This also includes providing information on how they operate and manage social and environmental challenges. The aim is to help investors, consumers, policy makers, and other stakeholders to evaluate the non-financial performance of large companies. Ultimately, the Directive encourages European companies to develop a responsible approach to business.
Why has the EU Non-Financial Reporting Directive created opportunities in fixed income?
One aspect of this law is that it requires previously unrated or poorly rated companies to increase transparency when issuing debt. As a result, many companies are now actively working to improve corporate governance and channels of communication. Because more companies are working on reducing their environmental and reputational risks and even legal risks, there are now many more opportunities for sustainable fixed income investment.
From our perspective as investors, ESG is a natural selection in risk management. The EU Non-Financial Reporting Directive is just another tool that enables us to conduct more thorough due diligence of a company; the balance sheet, governance structure, and environmental issues to name a few. The better we understand a company, the more we can minimise our risks.
What is your experience of ESG in the high yield sector?
Inevitably, investing in the sustainable high yield bond market is higher risk. It involves a complex analysis of companies’ opaque debt structures. There are also reporting inconsistencies and gaps in accessible information which make it difficult to compare companies. Often, they are completely new to the concept of sustainability ratings and the rating process itself.
However, our investable universe is limited to around 1000 companies. Because we have been investing in this sector for over 15 years, we have been able to develop relationships with our target companies. In some cases, we already invest in their bonds and the companies approach us with further financing needs. In others, our investing approach provides added value.
You state that your approach adds value. How does this work?
The European car industry is a good example of where we can add value. In terms of components, most cars are produced by the suppliers and almost 60% are privately held. To begin with, many of the companies that we invested in had no published data and there was very little transparency in their operational structure. Yet we found that most complied to sustainable standards, but their lack of active public engagement meant no sustainability rating which limited their financing options and potentially raised the overall costs of financing. We were able to offer guidance on sustainability standards, resolving problems in resourcing as well as communication procedures and subsequently their ESG ratings improved.
How does JAR Capital incorporate ESG factors into the due diligence process?
There is undoubtedly a lack of information in this sector. Until recently, incorporating ESG factors into fixed income investment analysis, particularly in high yield, was easier said than done. Unlike the equity space, there have been no ESG credit ratings (rating agencies had little or no access to ESG information) or sustainability indices against which to benchmark performance.
However, we have always assessed environmental, social and corporate governance factors as an integral part of the decision-making process. In the last decade, we have developed our own ratings universe, partnering with ISS-oekom, one of the largest independent rating agencies in the sustainable space. Additionally, we now employ ESG experts to enhance our analysis. Our extensive due diligence has meant that we have had no defaults in any of our funds.
What’s next for ESG in the high yield sector?
We are now seeing more wide-ranging approaches to high yield debt. Advancements in technology mean that there are more sophisticated methods of data collection and interpretation. We now have a range of benchmarks to draw from as well as highly regarded sustainability standards, both private and governmental. In March 2019, the European Parliament adopted rules under its Sustainable Finance Action Plan to require asset managers to use a common reporting standard to disclose how they consider ESG factors and to prevent them from greenwashing.
On a private level, the FNG Label, established in 2015 for sustainable mutual funds provides a transparent standard for funds which pursue a consistent and rigorous sustainability strategy.
In time, integrating sustainability criteria should become a standard part of investment analysis. But we strongly believe that ESG should involve active engagement and dialogue with analysed companies, providing them with incentives to improve their ESG credentials. In the long run, this will benefit both investors and issuers.