A Boston-based fixed-income manager with $17.5 billion in assets under management has developed a new method that it believes is critical to reducing risk in its portfolios.

Breckinridge Capital Advisors, a high-grade fixed-income manager, now uses its new sustainability model to rate corporate and municipal bonds by assessing what it expects a borrower's future costs will be from environmental, social and governance factors. The firm began developing an expertise in sustainability two years ago and has added three analysts over the last 18 months to help build the new model.

“We believe that future costs associated with unsustainable practices have to be recognized and reflected in the price of the bond,” says Peter Coffin, Breckinridge's founder and president. “Consequently, in addition to evaluating a borrower’s financial fundamentals, our credit research methodology systematically analyzes extra-financial considerations, such as environmental impact, essentiality, governance and connection with community. We believe that these types of factors are crucial to evaluating a company or community’s ability and willingness to pay back its bond holders, and will play an important part in improving long-term risk-adjusted returns of our portfolios.”

In particular, Breckinridge looks to see how bond issuers handle:
 
• Regulatory-environmental risk. Corporate issuers that manage their environmental impact efficiently may reduce this risk. The consequences of mismanagement were clearly demonstrated by BP’s 2010 Gulf of Mexico oil spill, which has had an acute impact on the company’s credit risk premium and corporate reputation, Breckinridge says.
 
Close monitoring of environmental impact may also help certain bond issuers more efficiently manage resources, the firm adds, and these issuers may prove better able to succeed if energy regulations increase. General Electric, for example, has reduced its dependence on water and energy and cut its greenhouse gas emissions as part of its “ecomagination” initiative, Breckinridge notes.
 
• Controversy Risk. Controversy risks can arise any time a corporation fails to adequately engage employees, customers or other key stakeholders when implementing a policy, Breckinridge says. Bank of America suffered when unhappy customers publicized mortgage and foreclosure problems and media scrutiny ensued, the firm noted.
 
“For companies like this, managing a “social” footprint is an integral component of brand management. We believe that brand diminishment has a clear impact on bond prices and price volatility,” the firm says.
 
• Managerial Risk. Corporations that evaluate their business practices through independent boards and audits may be less likely to sanction wasteful executive pay packages or accounting gimmicks, Breckinridge says.
 
Management and governance practices are also associated with better disclosure of financial and non-financial company information. For example, Praxair, the largest industrial gases company in North and South America, is an industry leader in ESG reporting, particularly on carbon emissions and resource use, Breckinridge says, and the company could communicate sustainability concepts to customers, suppliers and investors and take advantage of related market opportunities.