Stewardship: Fixed income

Transcription

1 Stewardship: Fixed income Building value for the longer term Integrating environmental, social and governance (ESG) factors into our fixed income investment process

2 Aberdeen investment philosophy Aberdeen Asset Management is a global asset manager with a broad range of investment capabilities. As a pure asset manager, without the distractions of other financial services activities, we are able to concentrate all of our resources on our core investment management business. We invest on behalf of thousands of individuals, whether aggregated by traditional investment institutions or by wealth managers, or who invest in our products directly. We acknowledge our fiduciary duty to preserve and enhance value in the interests of all the beneficiaries on whose behalf we invest. How we invest Every asset class and every strategy within it has a transparent investment process developed over multiple market cycles. A robust focus on long-term value creation is at the heart of our investment approach. Although the processes vary, common features include: First-hand research Team based investing Risk focus Long-term view Our investment professionals are always in or near to the territories in which they invest. By conducting first-hand research, we get a complete picture of financial trends, risks and opportunities from the local level up. We believe talented, diverse and close-knit teams deliver consistently better results than individuals. All stages of our investment processes rely on collegiate thinking. Our goal is always to deliver returns at an acceptable level of risk. Diversification, risk at each stage, plus robust knowledge of every holding, help us smooth volatility and minimise potential loss. While retaining the flexibility for tactical investing, we realise returns for our clients primarily by taking long-term, high-conviction positions in quality investments. For every investment we make, we analyse the risks and opportunities which could affect its value in both the short and longer term. This includes those risks and opportunities often referred to as environmental, social and governance factors (ESG). This report sets out how we integrate ESG issues into our fixed income investment processes. We invest on behalf of thousands of individuals who entrust their savings to us to protect and enhance over the long term, and act as stewards of their assets. Increasingly, this requires us to integrate ESG factors both the risks they pose and the opportunities they provide into our products and services. Brad Crombie Global Head of Fixed Income 2 Stewardship: Fixed income

3 Fixed income: a global approach Our fixed income investment process is founded on three simple investment principles research, relative value and portfolio construction, with risk management integrated at every stage. Risk management Risk management Research Relative value Portfolio construction Risk management Risk management Investment process Comprehensive proprietary research forms the foundation of our investment process. We have an intensive, fundamental, bottom-up approach to our research, which is produced by a large team of experienced analysts located across our regional offices. This structure enables research to be sourced, analysed and interpreted in the most effective way according to local market speciality and the location of our products. Proprietary fundamental research drives our robust relative-value process in which we seek to maximise risk-adjusted returns at the whole-portfolio level. We want to ensure our clients are rewarded for the risks they take in their portfolios. The team seek to identify investments where our view on valuation differs from the market, and that difference benefits our portfolio. We consider fair value estimates, and we also consider the potential price volatility. Portfolio construction involves identifying attractive investment opportunities identified through the first two steps which match our client risk-return profile. Using a combination of qualitative and quantitative inputs, we have a disciplined and rigorous process for managing risk at every stage. We believe our team-based approach improves decision making and allows for a more robust process. Over time, as securities reach or exceed their value potential, we replace them with new undervalued ideas. This improves the efficiency and transparency of our risk management as investments are focused on those securities with the most upside potential. We believe that, at worst, owning overvalued investments exposes clients to unnecessary risk given these securities prices are by definition skewed to the downside when fully valued and at best, inhibits the ability of the portfolio to invest in ideas that have upside potential. Forecasts We forecast an issuer s future financial results, but our work encompasses more than just numbers. While we project revenues, costs, capital spending, and other important cash flows, we are equally focused on what could change our outlook materially, such as external factors (e.g. regulation, technology, disruption) or internal (e.g. product pipeline, management succession). This approach enables us not only to forecast future leverage metrics but also scenarios that may be likely. aberdeen-asset.co.uk 3

4 Stewardship in fixed income: corporate debt Aberdeen has been investing in corporate debt for decades and we therefore understand that extensive examination of credit risk stretches far beyond looking at a company s balance sheet. In fact, this is only the beginning of an extensive credit risk. Examining ESG factors forms an integral part of Aberdeen s approach to investing and is therefore employed at numerous levels in our bespoke investment process. ESG a fundamental part of all fixed income research Aberdeen believes that the basis for all investment is fundamental research which is independent, forward-looking, and conducted at a regional level. By including the examination of ESG factors into our research, investment teams can more accurately identify and understand all the risks and opportunities presented by a potential investment. As a signatory of the Principles for Responsible Investment (PRI), we follow the PRI s reporting framework and adopt a two layered approach to stewardship - level 1 (ESG integration) and level 2 (ESG screening and thematic strategies). Two levels are necessary, because not all ESG factors carry the same relevance for the credit risk of an investment. This may be because a particular factor looks so far into the future that the related risk falls outside of the investment horizon; or because the ESG factor in question does not have material impact on a company s business model. However, if a factor is important to a client, then we will respond accordingly. Level 2 allows us to incorporate individual client needs without impacting our risk-based credit process. It is quite common for fixed income mandates to tailor the investment universe in terms of quality, domicile and duration. Therefore, adding another dimension of customisation in the form of level 2 is a familiar process. ESG Level of Level 1 Integration All credit mandates Level 2 Screening and thematic investment Customised - client driven As the risks and opportunities facing companies grow and diversify, increasingly ESG factors are having a material impact on the credit assessments of corporate issuers. Wolfgang Kuhn Head of Pan European Fixed Income 4 Stewardship: Fixed income

5 Stewardship in fixed income: corporate debt Level 1: Integration The of ESG risk factors is an integral part of Aberdeen s credit risk assessment process. This level forms part of the standard for every investment decision made by portfolio managers and is irrespective of specific client goals. This process ensures credit analysts are assessing ESG factors when establishing the credit risk of an issuer. The assessment is on the basis of an analyst s understanding of the current or potential risks to the credit profile that arise from ESG factors and management s ability to appropriately monitor or mitigate them. Credit risks which stem from ESG factors are classified as low, medium or high for all issuers analysed. We use external ESG to supplement our own research. Level 1 also includes engagement. While bondholders and lenders are not the owners of the businesses in which we invest, and do not elect directors or vote on governance resolutions, we do meet with management to understand a company s strategic plans and financial objectives. The level of direct engagement by bondholders and lenders generally rises with the risk profile of the issuer and is determined by a number of factors including issuer size and geographical location. Engagement therefore varies among our fixed income teams but the consistent theme remains that we are long-term investors who closely monitor the evolving risks and opportunities of our positions to derive the best returns for our clients. Cash-flow Macro backdrop Structure Asset valuation Company Industry Total Analytical Package (TAP) Covenant ESG Financial forecasting Forward credit rating Downside scenarios Outputs Investment rationale Outlook Other relevant factors ESG score Definition Documentation Low risk No ESG risks identified, or no risks identified which have a No further documentation required. material negative impact on our credit assessment. Medium risk One or more ESG risks identified as having a material negative impact on the credit assessment of the issuer, which management has not addressed or is unable to sufficiently mitigate (e.g. heavy albeit legal pollution, employee unrest, minor governance issues). High risk One or more ESG factors identified as having a major negative impact on the credit assessment of the issuer, which management has not addressed or is unable to sufficiently mitigate. (e.g. significant governance concerns, very weak environmental track record, activities which may become illegal). Identification of the risks and a description of their potential impact. Impact of ESG assessment on Aberdeen forward looking rating to be quantified where appropriate. Identification of the risks and a description of their potential impact. Impact of ESG factor on Aberdeen forward looking rating must be quantified. aberdeen-asset.com 5

6 STEWARDSHIP IN FIXED INCOME: CORPORATE DEBT CONTINUED Level 2: Screening and thematic investment This level is fully customisable and allows clients to specify a wide range of ESG-related parameters for portfolio managers. Level 2 is exclusively client-driven, and can take different forms, including: Negative lists Foot printing, for example low carbon Norms based exclusions, for example driven by the Thematic universe definition, for example green or social bonds UN Global Compact Climate-risk management Inclusion, for example a best-in-class approach Scoring, using either our internal risk assessments ratings or external ESG ratings Level Criteria Filter Example Level 1 Credit research ESG integration ESG risk assessments are included in our credit research process Integration All credit mandates Stewardship centre Engagement Our Stewardship Centre coordinates our engagement across asset classes Level 2 Negative lists Exclusion list No controversial weapons Screening and thematic investment Customised Norm-based exclusions Global Compact compliance No violation of Principle 2: working against corruption Score-based inclusion Best-in-class Only the top 50% of companies by ESG score Footprinting Benchmark comparison 150 tons of CO 2 per USDM of revenue vs 500 tons in the benchmark Thematic investment universe definition Climate risk management Use of proceeds Preparedness Targeting outperformance in health and safety Investment strategy designed to mitigate energy transition risks Level 2 example: low carbon investing As countries implement new climate regulations and budgets, the resulting impact will be far reaching. Interest in carbon approaches by countries, companies, individuals and wider stakeholders is increasing. To meet this demand we are able to provide clients with a portfolios which have a lower carbon footprint than the benchmark, both in terms of carbon output and intensity. In this way, we can offer a solution that enables clients to capitalise on the trend towards a low carbon world. Our investment teams can manage the carbon exposure of portfolios by selecting best in class positioned issuers within peer groups on a current and historical carbon emissions basis while also factoring in future carbon exposure. This strategy inevitably highlights that fossil fuel heavy industries, in for example the utility or energy related sector, will be the most at risk to rising regulatory pressure. We therefore do not limit ourselves to beating a benchmark of carbon emissions but seek to find new ways to capture the low carbon market transition by identifying key emerging opportunities. We currently manage over 1 billion in a low carbon fixed income portfolio. The drive towards decarbonisation means that investors are increasingly interested in the impact climate change and associated regulations will have on portfolios. Our risk-focused, research based approach means we are well placed to respond to demands for low carbon strategies. Cindy Rose Co-head Stewardship 6 Stewardship: Fixed income

7 Stewardship in fixed income: sovereign debt When analysing sovereign bonds, we focus on assessing the creditworthiness of countries, in both the short and long term. As with our approach to corporate debt, we examine factors which may have a material impact on the credit risk of the underlying investment. We assess how these factors are managed and mitigated, as well as the opportunities they create for the sovereign issuer and therefore the investor. For sovereign debt, the assessment of ESG risks is more focused on social and governance indicators than environmental factors as they generally have a more direct link to a country s liquidity and solvency profile. Intuitively, adequate social protection empowers a higher percentage of the population to participate in the economy, allowing the government to collect more tax revenue. A stable government with peaceful elections is also more likely to honour its debt obligations throughout economic cycles. Environmental risk, on the other hand generally, does not have an immediate effect on government s ability or willingness to pay its creditors. But environmental concerns can be significant to citizens wellbeing. For example, the problem of heavy pollution might manifest itself through social grievances, which could destabilise the society. When conducting sovereign research we analyse a country s demographics, political structure and election dates. We gain external input from the World Bank s Doing Business Report, World Bank s World Governance Indicators, Yale University s Environmental Performance Index, Transparency International s Corruption Perception Index, Sustainalytics Sovereign ESG assessment and the UN Sanction List. These inputs are presented at our sovereign strategy meeting every six weeks. Based on the metrics listed, we have developed a proprietary ESG scoring model. The model scores countries based on their rankings on each metric and then provides a rating for all three aspects of ESG. With each factor, we also look at the historic trends of each country s performance. The resulting score therefore looks at the historic standing as well as the trajectory. In addition, we incorporate country analysts forward-looking assessments to capture recent events and our own forecasts of each country s near term trajectory. These outputs are not followed blindly; they are supplemented by regular country visits and other qualitative factors, such as political and event risk, which could have an impact on market prices and credit quality. For sovereign issuers we also offer clients a detailed comparative assessment and scoring of a broader range of ESG factors which can be customised to suit specific ESG requirements. Country example: Malaysia Malaysia provides a good example of how we take ESG considerations into account during our country allocation process. In early 2015, several high profile politicians, including the Prime Minister, were mired in a corruption scandal linked to the sovereign development fund 1MDB. It attracted national attention when reports traced 1MDB s missing funds to Prime Minister Najib s bank accounts. The ensuing investigation exposed more fault lines in Malaysia s institutions and shook public faith in the government. Although Malaysia s standing had been stable historically in the World Bank s World Governance Indicators and Doing Business, we thought the recent political developments reflected a deteriorating trend in the country s governance standards. This is particularly relevant now that the Malaysian economy is facing the challenge of lower commodity export revenues and the government is likely to be distracted due by political scandal and therefore less likely to push forward structural reforms. Our decision to have an underweight position in Malaysia took into account this negative development and the possibility of higher political instability which could lead to worsening credit fundamentals. aberdeen-asset.com 7

8 Stewardship across the asset classes Stewardship is a fundamental element of Aberdeen s investment process across all asset classes. We adopt a holistic approach to risk and opportunity assessment, and therefore ESG factors are considered throughout the investment process. Equities For our active equity business, our bottom-up stock selection process is long-established and, with lengthy average holding periods of generally eight years or more, we actively consider matters of long-term value for both potential and held investments. We maintain close contact with the companies in which we invest and this means we can respond pragmatically to their individual needs and seek to consider what is in the best interests of the company and its shareholders at the relevant stage of its development. We focus on company fundamentals and the material issues which may have a negative impact on the business. These issues can vary greatly between companies and also individual industries. We have regular and ongoing dialogue with the management and boards of the companies in which we invest and this engagement is at the heart of our investment process. By maintaining a positive working relationship we find we can often help companies find positive ways forward, and educate management about the expectations of their shareholder base. Property If both direct and indirect environmental and societal impacts are well managed, the portfolio risk of our property investments can be reduced, with higher rental growth and occupancy rates achieved. The consideration of ESG factors is integrated into each stage of our investment process from allocation to selection and management. Our approach is not just about saving carbon and energy. It s about managing our risks and increasingly operational efficiencies to the longer term benefit of building occupiers and ultimately our investors. Multi asset Our multi asset funds are built around a clear philosophy of diversification and utilising the team s expertise in managing the market risks of traditional and alternative assets. We are able to draw on the breadth of Aberdeen s investment capabilities, including ESG integration, to provide multi asset solutions to meet client needs. Alternatives For indirect investments, our first step is to understand how managers integrate ESG considerations into their investment and decision making. Integrating ESG factors into this process and decision making can provide additional insight into the quality of a company s management, its culture and risk profile as well as identifying opportunities for growth and improvement. It is therefore important not only for value protection but also for value creation. As with the other asset classes, ultimately the attractiveness of any investment opportunity will be driven by a broad range of factors. In some cases ESG issues will have a limited impact on the potential risks or opportunities of an investment. However, particularly for less liquid private markets and our investments in less developed markets, these issues can be meaningful in our assessment. This means that we have, and will, make decisions incorporating metrics other than just financial ones, including not progressing with an investment on ESG grounds even when on financial metrics alone we would have chosen to proceed. Quantitative investments The quantitative investment team build bottom-up equity portfolios targeting factors which predict out-performance. Our systematic investment process allows the integration of any ESG factor into a client s portfolio. This can include a customised implementation targeting a positive exposure to any desired ESG factor at the portfolio level versus the benchmark, for example overall ESG score, carbon profile or gender diversity. The team also offer the more standard exclusion methodology of not holding stocks and industries which do not meet the client s requirements. 8 Stewardship: Fixed income

9 Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Aberdeen Asset Managers Limited Bow Bells House, 1 Bread Street, London EC4M 9HH Telephone: +44 (0) Fax: +44 (0) aberdeen-asset.com Registered in Scotland No Registered Office 10 Queen s Terrace, Aberdeen AB10 1YG /16