How investors are approaching ESG factors and credit risk

Integration appears by far the most popular strategy for incorporating ESG factors in FI investment decisions, followed by integration with screening approaches. Strategies containing a thematic element are less popular. Across FI instruments, governance is consistently cited as the ESG factor that is considered the most systematically.

Investors are using ESG analysis in their investment decision making at various levels. A significant number of FI investors are integrating ESG in their internal credit rating and credit risk assessment.

Most managers claim to have partial integration of ESG analysis in their investment process, or are in the process of integration. However, where ESG consideration rests only with ESG analysts, views differ on how they are integrated into mainstream credit analysis and incorporated by PMs in their final investment call.

The majority of investors interviewed admit to being less advanced on systematically incorporating ESG into FI valuations, including credit analysis, compared to equity investors. Overall, ESG consideration is still far from being an integral element of the credit assessment process.

ESG analysis and integration

ESG analysis is generally conducted by ESG analysts and then shared with credit analysts; investors interviewed noted that securing internal investment buy-in for ESG consideration is still a work in progress. Many of those interviewed are cognisant that this is a potential weakness as the link between the gflag h raised by ESG analysts and the final credit quality assessment may not be systematic.

“It is up to the PMs to get in touch with the ESG team, if they are looking at a new issue and aren’t sure about which ESG issues they should focus on.”

Addenda, Lambert & Minns

“To date our approach to ESG integration has been more as a series of ongoing conversations with credit analysts to raise awareness and understanding. We are not yet at a stage where we are explicitly factoring a formal weighting to it in portfolio construction.”

BlueBay AM, Ngo

“An important part of the ESG integration process for us has been to work on building relationships internally, in order to broaden understanding within investment teams and achieve increased buy-in…It’s a gradual process of informal training on what ESG means…we use scores as a flagging mechanism which credit analysts can then use to investigate issues further and where relevant, integrate the findings into their analysis and recommendations.”

Legal & General, Ogden

Blend of qualitative and quantitative approaches

Similar to the CRAs f methodology, ESG integration in credit risk analysis is based on a mix of qualitative and quantitative indicators. In most cases, analysis relies on publicly available information as well as proprietary indicators.

“We use multiple factors in our analysis covering quantitative data as well as qualitative issuer interviews…we do look at Moody’s Investors Service, DBRS and S&P Global Ratings analysis on corporate bonds but then we form our own analysis.”

Addenda, Lambert & Minns

“ESG model draws upon carefully selected series of research, statistical and survey data provided by international organisations, offering a comprehensive framework to complement our analysis of country-specific macroeconomic developments. ESG factors make up 40% of the Country Credit Model (CCM), our proprietary analytical tool that rates relative sovereign debt creditworthiness in emerging markets.”

Neuberger Berman

“To understand the implications for financial variables, such as spreads, returns or rates, it is necessary to econometrically integrate ESG dynamics into valuation models”

Global Evolution, Hagen J.

Subjectivity

Managers select appropriate factors and weights, inevitably incorporating an element of personal judgment in their analysis, similar to CRAs. However, these approaches are seldom back-tested. Even when quantitative factors are included, the investment decision depends on an analyst fs final judgement.

“From an investment perspective, we see the G, governance, as being the most relevant, so we wanted to acknowledge that by giving that component the highest weighting in generating an overall issuer ESG score using E, S and G scores from our third-party provider…we have done that by making the G score 50% and the others [S and E] 25% and 25% of the overall score.”

BlueBay AM, Ngo

The ESG in Credit Ratings Initiative receives financial support from The Rockefeller Foundation