Part 1: The evolution across asset classes
Adam: There are a couple of different factors at play for us in fixed income. The first is that even the idea of ESG integration itself is a little bit newer compared to equities, and hasn’t fully permeated the market yet. There’s this notion that fixed income is secondary in the RI field to equities, where an investor can vote proxies and opine on the direction of the business. However, that is not our view at BMO Global Asset Management, as we believe ESG is very much a fixed income consideration – as it is across all asset classes. As a bond investor, you’re funding a company’s new initiatives and that means you have the ability to impact their actions. If we reflect on ESG as a factor in our evaluation of credits, then it can have a significant impact on the cost of capital for a given security. While there is now growing acceptance from the broader market in our asset class, this wasn’t always the case. But on our fixed income team, we’ve weighed these considerations as a distinct factor within our credit analysis dating back to 2014, complemented by BMO’s rich history in the RI world. It’s incumbent on us to continue to be active on this front and stay ahead of the curve.
Part 2: Integration into our processes
Adam: In our credit research process, ESG is incorporated as a distinct standalone factor in analyzing the fundamentals of a company. This is important because ESG can identify additional risks and rewards as we think about what their ability and willingness to repay debt looks like. If a company has poor ESG metrics, that can be a crucial determinant in them having difficulties repaying their obligations. For instance, this is clearly evident in terms of governance, and in some ways that’s the most common, but you can also see this reflected from an environmental standpoint if a company takes on a huge liability, and sub-standard environmental practices impinge on their ability to execute on business plans. It’s a similar story if a company is not meeting guiding social principles; they can quickly fall out of favour with the market and rising reputational risk could impact their market share. . Sometimes, ESG is viewed as an outside factor, but really it poses fundamental risks, and it is an integral component to the evaluation of credit risk to our team. Importantly, our process is oriented around relative value. We believe we can understand the risks on specific issuers better than the market and third-party providers, which allows us to buy mispriced bonds and capture potential upside and additional value for our clients.
David: In Disciplined Equity, there are now four parts of our process where we fully integrate ESG, including stock analysis (where we use a proprietary quantitative model to which we’ve recently added additional factors); portfolio construction (where we look at portfolio-level ESG exposures); overall portfolio monitoring and automated review of whether any companies have been downgraded on their rating, which would ultimately impact our buy/sell decisions; and active ownership in relation to proxy voting and engagement with management. The difference vs. the Fundamental Canadian Equities team is that we centralize this latter part through the RI team in London – we don’t do the engagement ourselves because of our largely quantitative approach.
Adam: As David mentioned, we similarly incorporate our own research into our proprietary scoring system, and don’t rely on third parties for what they believe are the fundamental risks of an issuer. We’re aware of their views because of the potential technical impact, similar to how we view credit ratings from the ratings agencies, but our scoring is based on our own work and input from our RI team, which has certainly been additive to how we think about ESG within credit.
Part 3: ESG examples from the field
Jennifer: A good example is Waste Connection, the third largest solid waste company in North America. Workforce turnover is very high for the industry because hauling garbage is hard work. Particularly, before COVID, there were many years where competition for labour was fierce, specifically in the U.S., which only exacerbated the turnover problem. Five years ago, the company took a hard look at their practices, and improved employee retention through hiring processes and creating an accountable environment where people could provide feedback on their managers. As a result, their turnover percentage lowered significantly and is now less than their peers, which has a huge impact not only socially, but to the bottom line.
Adam: I think a great example from my perspective is Volkswagen, which went from the darling of ESG while they were falsifying data to a company with the absolute worst scoring after they were caught. What’s interesting is that our RI team engaged with them after the scandal, and observed they were doing the right things on the margin to improve their forward score, which is a factor to consider, and exemplifies our approach of relying on our own research rather than third-party data. This was a company moving forward in the right direction, which gave them a better score in our books.
Part 4: Greenwashing – the firsthand impact
Adam: In the context of fixed income, there have been a lot of issuers realizing that there’s now an active bid for green and sustainable bonds, so there is an incentive for companies to label their debt that way. We have to acknowledge that money is fungible, so if a company issues a bond, it may in one pocket be achieving something sustainable while not adhering to ESG principles in another pocket. There isn’t really consensus on green bonds yet. There is nuance that has to be applied, and really examining the issuers and the bond – and not just accepting what they say at face value – is key, in the same way we wouldn’t accept financial projections without doing our own homework.
Part 5: What makes BMO Global Asset Management different
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This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance. All investments involve risk, including the possible loss of principal. Past performance is not a guarantee of future results. The mention of specific securities and/or portfolio holdings is not intended as a recommendation to buy, sell, or hold such securities. The returns on a portfolio consisting primarily of Environmental, Social and Governance (“ESG”) aware investments may be lower or higher than a portfolio that is more diversified or where decisions are based solely on investment considerations. Because ESG criteria exclude some investments, investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria.