Companies rely on bond issuance to finance their goals - which gives their owners leverage to put pressure on companies. This raises the question: Why not let more bondholders play their part?
According to PRI Statistics 2018, 73% of fixed income signatories are now involved in ESG issues. So why has the corporate world not yet felt the impact? Why don't the corporate governance codes, which aim to promote investors' active ownership, apply to fixed-income securities? ShareAction, the charity that promotes responsible investment, recently published a study showing that large bondholders were "sleeping giants" with little appetite for strong engagement - as evidenced by their failure to join the industry's most important climate change initiative to date - Climate Action 100+. One possibility is to get involved through direct, cooperative and service activities.
Rule number one - constructive dialogue
In times when positive returns are difficult to achieve, it seems that profitable companies are not forced to engage in dialogue with investors. Perhaps the bondholder is reluctant to start the conversation at all.
Such a defeatist attitude is not helpful for the cause of sustainability; it is also out of place. Bondholders are able to make an impact, and the best way to do that is through constructive dialogue. Constructive dialogue requires thorough analysis and, not at least, patience. To convince a company of change, you need to be able to demonstrate the benefits of change - ideally from both an ideological and an economic point of view. In order to attract (and retain) the attention of the company, the direct and indirect added value resulting from the proposed changes should be precisely defined.
Engage - reduce risk and increase return
From an impact perspective, best-in-class companies are therefore less relevant to an engagement strategy aimed at making the world a better place or increasing revenues, or preferably both. It certainly makes sense for a company that focuses on reducing business risk or increasing revenue from "doing the right things" to have a positive impact on shareholder value. It is the risk of doing business that has a downward effect, which is of paramount importance to bondholders, not the potential upside.
Compared to a company's share price, which can multiply several times over, the price of a bond has a limited upward trend - but both can go to zero. This effectively means that a loss on one bond cannot be covered by another's profit, as could be the case with equities. This underlines the focus on the downside risk for bondholders, where ESG effects can have a significant impact. ESG risk is also important for companies. In the worst case of an environmental or human rights disaster, this could lead to their losing their operating license. It is therefore important to show companies that if they are to raise money for future projects, their interests should be aligned with those of the bondholders.
The demonstrable reduction in business risk will allow the company to obtain better terms for its financing needs, as bondholders will then be willing to lend money at a lower credit spread. It should also be noted that improved ESG profiles for bond issuers can lead to better credit ratings for credit rating agencies, which now integrate ESG considerations into their rating process. For existing bondholders, this means that the market will accept a lower yield, which will increase the yield on bonds. Although very difficult to measure in real life, several academic studies confirm that this is the case.
Thomas Bjørn Jensen is senior portfolio manager and Antonia Draghici, analyst at Sparinvest.
Maciej Woznica, chief portfolio manager, head of Credit at Sparinvest, will be presenting ESG in Credit: Perception vs Reality of Engagement in High Yield Portfolios at this year's edition of the Nordic Investment Managers Forum, which takes place October 16 in Zurich, 17 in Munich and 18 in Luxembourg. Maciej manages the Value Bonds team and focuses on portfolio management within high yield and emerging markets. He has been with Sparinvest since 2015.
For full details about the NIMF speakers from groups including DNB AM, Jyske Capital (Jyske Bank), Storebrand AM and Sparinvest, visit www.nimf.lu
