Virtue in corporate environmental, social and governance debt is becoming lucrative for investors and companies alike, but vice still has its rewards in the hunt for yield.
Investors say companies in sectors that many ESG funds would exclude, such as tobacco, fossil fuel and gaming companies, can still access credit markets with relative ease, and sometimes even lower their funding costs.
The trend of linking borrowers’ debt repayments to ESG criteria remains relatively new. There are enormous variations in standards for everything from recycling targets to employee diversity goals. Investors’ willingness to police those guidelines also differs. And the rewards for compliance or the consequences of failure is simply too paltry.
“ESG pays off, but not always necessarily short-term,” said Chris Brils, a portfolio manager at Actiam NV, estimating the penalties for a failure to comply with such criteria at around five to 10 basis points. “It’s nothing that significant yet.”
There’s also the worry that excluding companies or sectors that haven’t embraced the ESG agenda may hurt returns.
Chris Bowie, a partner at TwentyFour Asset Management in London who helps oversee more than 16 billion pounds ($22 billion), found that returns dropped by 1% a year when he stripped out companies in the oil and gas, tobacco, gambling, and alcohol sectors while testing his first ESG fund. The exclusions also increased the fund’s volatility due to a lack of diversification among assets.
It’s Personal
Bowie, who launched a sustainable short-term bond fund in January 2020, said being an ESG manager can be challenging as corporate policies are wide open to interpretation and beliefs about sectors can be personal.
“We have spoken to investors who for religious reasons see no issue in having companies that make alcohol in the fund, and others that will say nuclear power is acceptable, opinions can range across cultures, religions and regions,” Bowie said in a phone interview.
In a previous role as head of European high-yield debt at ABN Amro Bank NV, Brils said he wasn’t allowed to buy the debt of Netherlands-based Imperial Tobacco, but was able to invest in German arms manufacturer Heckler & Koch GmbH, which supplies the U.S. military.
“So I could buy the GI in Iraq a new gun but not allow him a pack of smokes,” Brils said.
The complexity of ethical investing is compounded by companies promoting an ESG agenda regardless of the nature of their product.