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Creating sustainable multi-factor bond portfolios

Creating sustainable multi-factor bond portfolios

29-06-2021 | Insight

Our simulations show we can do this without materially reducing factor exposures and hence the alpha potential.

  • Olaf  Penninga
    Olaf
    Penninga
    Portfolio Manager
  • Patrick  Houweling
    Patrick
    Houweling
    Co-Head of Quant Fixed Income and Lead Portfolio Manager

Speed read

  • Multi-factor bond portfolio more sustainable than reference index 
  • We increase sustainability without materially reducing factor exposures
  • Sustainability is integrated using a range of methods

At Robeco we believe that sustainability and climate considerations can have a material impact on the future performance and financial health of issuers of sovereign and corporate debt. Sustainability therefore plays an explicit role in our Global Multi-Factor Bonds portfolios. 

Multi-Factor Bonds is a broad fixed income solution that uses factors to select the most attractive credits and government bonds. The systematic nature of the strategy lends itself well to sustainability integration.

We apply a range of methods to improve the sustainability of these portfolios. Our simulations show that we can improve the sustainability without materially reducing the factor exposures and hence the alpha potential of the portfolios. 1

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Excluding controversial countries and companies

A first method we apply to our Global Multi-Factor Bonds strategy is to exclude controversial countries and companies from the investable universe. This exclusion policy is integral to Robeco’s sustainable investing approach and is part of our stewardship responsibilities.

Managing the ESG score and carbon emissions

When constructing or rebalancing the portfolio, we require the portfolio to have a better sustainability profile than the reference index. This implies that bonds from more sustainable companies and countries have a higher chance of being bought than less sustainable bonds. Thereby we strive for optimal factor exposures in a sustainable way.

We systematically ensure that both the government bonds and the credits in the portfolio have a better weighted average ESG score and lower carbon emissions than the government bonds and the credits in the reference index. We do this separately for credits and for government bonds as we cannot directly compare their sustainability scores. 

Our research shows that the impact of managing the ESG score and carbon emissions on the historically simulated portfolio return and volatility is limited. Therefore, the sustainability integration does not come at the cost of materially lower factor exposures.

ESG scores

The RobecoSAM Country Sustainability Ranking is a comprehensive framework for analyzing countries’ performance on a wide range of ESG metrics that we consider to be material and financially relevant for investors. The country ESG scores analyze 150 countries spanning emerging and developed economies and are updated semi-annually. 

For companies, the ESG scores are based on the S&P Corporate Sustainability Assessment (CSA), which is an annual evaluation of companies’ sustainability practices. Each year over 7,300 companies around the world are assessed, as part of a process that has been running since 1999, initially by RobecoSAM and since 2020 by S&P. The focus is on criteria that are both industry-specific and financially material. 

Carbon footprint

Each issuer’s carbon footprint is calculated by normalizing its greenhouse gas emissions (expressed in CO2 equivalents). Note that ‘carbon’ thus not only accounts for carbon dioxide (CO2) emissions, but also for other greenhouse gases, like methane and nitrous oxide. The carbon footprint of a country or a company gives insight into potential risks related to the transition to a lower-carbon economy. Issuers with a larger carbon footprint are expected to face more carbon-related economic, market and regulatory risks.

Fundamental checks for further ESG risks related to corporates

Next to the strategy’s quantitative assessment of sustainability risks, we build on the strong fundamental expertise of Robeco’s credit analysts to check if there are any additional environmental, social or governance (ESG) risks. Once the corporate bond ranking is constructed using our quantitative multi-factor model, our fundamental credit analysts check whether the top-ranked bonds have additional ESG risks that are not captured by the model. If material risks are identified, the model is overruled and the bond is not purchased or, if we had bought it previously, it is sold. Examples of such cases include a chemical company that faces financially material environmental risks, an energy company that experienced a gas explosion, and a company operating prisons and detention centers that is involved in human rights issues.

Engaging with companies and countries in which we invest

Lastly, to advocate sustainable business conduct and policy, we engage on topics related to the United Nations Sustainable Development Goals with a selection of issuers in which we invest. 

Although as bondholders we do not have formal voting rights at companies, we do exercise our influence as creditor to discuss how companies manage ESG risks and seize business opportunities associated with sustainability challenges. This constructive dialogue aims to improve companies’ sustainable behavior, as this can result in better long-term performance of the company and hence have a positive impact on our investment results and on society. We focus on the most material issues that we would like the company to address. 

We recently expanded our engagement to countries. Like with corporates, we base our engagement with sovereigns on the UN’s Sustainable Development Goals. All countries in our investment universe have signed up to these goals, so this offers a common framework to discuss sustainability issues that we would like the countries to address in their policies. 

1The details of our approach to sustainability in Multi-Factor Bonds portfolios are outlined in our research paper, ‘Integrating sustainability in Global Multi-Factor Bonds’, June 2021

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