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Credit analysis and ESG: a perfect fit

17-09-2014 | Insight | Jankees Ruizeveld, Taeke Wiersma One of the cornerstones of the investment philosophy of Robeco’s Credit team is that avoiding losers is more important than picking every winner. The team believes that integrating environmental, social and corporate governance (ESG) factors into its analysis strengthens the ability to assess the downside risk of its credit investments. The Credit team is therefore convinced that ESG and credit analysis are a perfect fit.

Speed read:

  • ESG strengthens ability to assess downside credit risk 
  • Leveraging dedicated engagement and sustainability team 
  • A perfect fit with Robeco’s proprietary research approach
Robeco: a strong proponent of sustainability investing
The integration of ESG factors in Robeco’s credit investments is not a stand-alone practice. As a signatory of the United Nations Principles for Responsible Investment since December 2006, Robeco as a firm is committed to the integration of ESG factors into its investment decision making and ownership practices. In that same year Robeco acquired RobecoSAM, a dedicated asset manager and recognized leader in sustainability investing (SI). Robeco is convinced that taking financially material sustainable issues into account improves its clients’ risk-return profiles and will also contribute to aligning the objectives of institutional investors with those of society at large.

Robeco’s ESG analysis is research driven
Shortly after its establishment in 1929 Robeco’s first director, Wim Rauwenhoff, decided that "every investment strategy should be research-driven". Today, Robeco is more convinced than ever that market inefficiencies can be exploited based on its proprietary research. The Credit team therefore takes its own knowledge and analysis as the starting point for its fundamental research, which includes its opinion on the ESG factors of all the companies under coverage.

Fundamental opinion based on five factors
The primary concern of a corporate bond holder is the company’s ability to repay debt. Key focus of Robeco’s credit analysis is therefore the cash generating capacity of the issuer and the quality of the cash flows. The team performs this analysis through a fixed format assessment of five different variables of which ESG is one. The other variables are the company’s business position, corporate strategy, financial profile and corporate structure. Based on these five factors the analyst assigns a fundamental score which expresses the overall fundamental view on a company for the coming year. The five factors are not stand-alone but are often intertwined; for instance, a change in ownership can impact a company’s financial position, and an international expansion strategy may introduce country risk into the business position.

ESG helps to understand downside risk
The prime goal of integrating ESG factors into Robeco’s credit analysis is to strengthen the ability to assess primarily the downside risk of its credit investments. Examples of these downside risks are the USD 28 billion scandal related fines for JPMorgan Chase; the USD 40 billion costs for BP related to the Gulf of Mexico oil spill; and the recent bankruptcy of Banco Espírito Santo as a result of weak corporate governance.

Using sustainability information in credit analysis perfectly matches the essential need to avoid the losers in credit portfolios.

Focus on financially material issues
Robeco believes that focusing on material sustainability issues will lead to measurable benefits for investors and society. When determining the relevancy of the ESG factors, the credit analysts therefore apply the same financial materiality principle, focusing on economically relevant issues. If these factors impact a company’s credit quality, financial markets should reflect this higher risk in a spread premium on the bonds. Investors want to be compensated for taking investment risk, which includes ESG related risks.

Conclusion: ESG integration improves the risk-reward profile
As a corporate bond holder’s primary concern is the company’s ability to repay debt, one of the cornerstones of the investment philosophy of Robeco’s Credit team is that avoiding losers is more important than picking every winner. The team believes that integrating environmental, social and corporate governance (ESG) factors into its analysis strengthens the ability to assess the downside risk of its credit investments. It performs this analysis by assessing five variables of which ESG is one.

The credit analysts focus on financially relevant issues. If the ESG factors impact a company’s credit quality, financial markets should reflect this higher risk in a spread premium on the bonds. Robeco believes that this focus on material sustainability will lead to measurable benefits for both investors and society.

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