By Antony Michels
Analyzing ESG factors with credit fundamentals for competitive returns.
“How much of our cash is invested in sustainable investments?” If you’re responsible for investing your company’s cash balances and haven’t already been asked that question by a C-suite executive or board member, get ready—you will.
The skeptical response. Some NeuGroup members facing this question remain skeptical about adding environmental, social and governance (ESG) criteria to their investment policies. Some of this skepticism surfaced at the recent Treasury Investment Managers’ Peer Group summit sponsored and hosted by HSBC Global Asset Management, where more than one participant said, “I am not going to give up returns” just to have an ESG-friendly portfolio. Fair enough.
You don’t have to give up returns. The good news takeaway from HSBC’s presentation on ESG is that corporate investors don’t necessarily have to sacrifice expected returns or yield when creating more sustainable portfolios. HSBC created a hypothetical ESG portfolio with sector and industry weightings, overall credit rating and duration comparable to an investment-grade benchmark. As the table shows, this sample ESG portfolio matched the benchmark’s yield with an ESG score that was 1.5 points higher than the benchmark. The theoretical portfolio did not have to sacrifice returns to achieve a higher ESG score (in fact, it actually picked up a few basis points) while limiting the exposure to ESG-related financial risks.
ESG Analysis. The framework for creating the HSBC portfolio depends partly on scoring an industry and companies on all three ESG components (where E+S+G=ESG). As the relevance of ESG factors varies in different industries and subindustries, weightings are assigned to each component accordingly. HSBC’s overall scores for the banking industry, for example, will emphasize governance issues (55% of its ESG weighting) over environmental considerations (≈ 10%). For automotive companies, by contrast, HSBC uses a 50% weighting for the environmental factor. Company ESG scoring is evaluated in the context of its industry sector.
So who provides these ESG scores?
Many providers publish ESG ratings and scores, including Standard & Poor’s, Sustainalytics, MSCI, Bloomberg and Refinitiv. The scoring and methodologies vary across providers; a recent report from State Street Global Advisors said, “The lack of standardization and transparency in ESG reporting and scoring presents major challenges for investors.” HSBC uses multiple ESG scoring sources in addition to proprietary quantitative and qualitative data in analyzing issuers to determine HSBC’s final ESG score and investment decision.
Tail risk benefit. Ratings agencies and credit analysts alike are paying increasing attention to issuer ESG profiles and incorporating material ESG issues in their assessment of creditworthiness. In this way, corporate cash investors can already benefit from increased awareness of the tail risks posed by ESG factors. And while some may be content to enjoy this “free lunch,” others are now considering adding ESG criteria to their investment policy menu.