With ESG factors becoming an increasingly important part of the investment process, here’s how Seix’s leveraged finance team seeks a fuller understanding of the companies in which we invest.
- Since our founding by Christina Seix in 1992, the investment process has been driven by bottom-up credit analysis that relies on our five core investment tenets—asset protection; cash flow /deleveraging; a company’s management team; its liquidity sources, and its competitive position. Building on proprietary systems developed in our early years to ensure compliance with socially responsible investing client guidelines, we integrated the review of environmental, social, and governance (ESG) factors into our existing credit process.
- A research analyst on the leveraged finance (LevFin) team will typically use an ESG checklist (as shown below) that we developed internally based, in part, on the Sustainable Accounting Standards Board (SASB) standards1.
- The ESG framework applied by LevFin seeks to identify a company’s ESG exposure as:
- Positive > 3-5
- Neutral 3
- Negative <3-1
- Positive scores are reviewed routinely since inclusion of these companies may lower overall performance risk.
- Neutral scores result in an annual review.
- Negative scores result in more frequent review to ascertain that risk factors of concerns are not deteriorating.
- Even lower scores (usually due to concerns regarding sustainability of the business model or risk of stranded assets) may be excluded at the discretion of the portfolio manager.
Case Study: A Telecommunications Company
In evaluating a potential investment, the Seix leveraged finance analyst will look at a company’s environmental, social, and governance record as follows. Each ESG factor is scored on a 5-point scale as follows:
1 – negative (unlikely to invest)
2 – negative (invest with caution/watch list)
3 – neutral
4 – positive (ESG supports credit improvement)
5 – very positive.
Here’s how one telecom company’s ESG integration checklist shaped up:
When it came to an American telecommunications company, environmental metrics such as air quality, water and wastewater management, and other ecological impacts were not applicable, but energy management was relevant. Seix research found that the company had implemented energy consumption reduction including decommissioning of old power-hungry UPS equipment and servers. The efforts save an annual 7 million kWh/year, which is equivalent to about 565,000 gallons of gasoline. In addition, the company was targeting a 20% reduction in CO2 by 2024, and a 25% reduction in electricity per terabyte by 2024.
Subsector score: 3.0
Seix looks at the Social part of ESG two ways: social capital and human capital.
While the telecommunications company in this case had no reportable issues on human rights and community relations, access & affordability, product quality and safety; customer welfare, or selling practices & product labeling, Seix leveraged finance analysts discovered that it limits use of customer data and with consent can offer customers other products and services. As for data security, the Seix analysts reported the company had no consumer data losses in the past three years.
Subsector Score: 3.5
As for the company’s human capital practices, labor practices and employee health & safety were not material in the Seix evaluation. However, the scorecard for employee engagement, diversity & inclusion showed that women accounted for five of the company’s 15 executives, four out 10 board members, and 30% of the workforce.
Subsector Score: 4.0
Business Model & Innovation and Leadership & Governance
The “G” of Seix’s ESG checklist is twofold. The G1 screen—business model & innovation—may include product cycle & lifecycle management, business model resilience, supply chain management, and physical impacts of climate change. The pertinent metric in this evaluation was material sourcing & efficiency. According to the Seix analyst, the company focuses on reducing waste, energy and materials and expects suppliers to do the same.
Subsector Score: 3.5
The G2 screen—leadership & governance—may encompass business ethics, governance, management of the legal and regulatory framework, and critical incident risk management. One relevant metric here was competitive behavior—this telecom company offers competitive products in many larger markets, while speeds available are materially lower in rural areas that that are less competitive, the Seix analyst noted. The other relevant metric was systemic risk management—in 2019 the company paid $65 million to settle consumer litigation concerning 911-emergency service versus $0 paid in 2018 and 2017.
Subsector Score: 3.5
The bottom line: Seix’s overall ESG score for this company was 3.3, but considering the divergence of ESG metrics and evaluation methodologies that investors might want to see, the Seix ESG integration checklist included third-party ESG scores and key operating statistics shown below. No one metric decides whether to invest or not to invest. ESG-related risks may be opaque and vary across sectors. And in some cases, other mitigating factors may trump a relatively low ESG score. Sometimes it can be a balancing act.
|3rd Party ESG Score||Key Operating Stats|
|Sustainalytics Rank||22.2||ISS Governance Quality Score||10 (worst)|
|RobecoSAM Rank||10.8||CDP Climate Score||4|
|Bloomberg ESG Disclosure||32.5|
For illustrative purposes only
Sources: MSCI and Sustainalytics publicly provided information; Bloomberg Industries ESG Dashboard
An MSCI ESG Rating is designed to measure a company’s resilience to long-term, industry material environmental, social and governance (ESG) risks. MSCI uses a rules-based methodology to identify industry leaders and laggards according to their exposure to ESG risks and how well they manage those risks relative to peers. Our ESG ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B, CCC).
Sustainalytics Rank. Sustainalytics’ ESG Risk Ratings are categorized across five risk levels: negligible (0-10), low (10-20), medium (20-30), high (30-40) and severe (40+).
RobecoSAM Rank. RobecoSAM Smart ESG methodology uses quantitative analysis to remove the bias that clouds standard ESG data and helps clarify the true sources of sustainability. As a result, investors are better equipped to reduce risk, spot opportunities, and improve portfolio performance.
Bloomberg ESG Disclosure scores rank the relative performance of companies across four key focus areas of diversity, tenure, director over boarding, and independence.
GHG/Revenue. This metric is a carbon responsibility metric that describes the associated greenhouse gas impact (metric tons of CO2) per $1 million in revenues.
ISS Governance Quality Score uses a numeric, decile-based score to indicate a company’s governance risk relative to their index. An overall score in the 1st decile (QS:1) indicates relatively higher quality governance practices and relatively lower governance risk, and, conversely, a score in the 10th decile (QS:10) indicates relatively higher governance risk. Companies also receive a score for each of four categories: board structure, compensation/remuneration, shareholder rights, and audit & risk oversight.
CDP Climate Score. CDP, formerly known as the Climate Disclosure Project, is an international non-profit organization based in the United Kingdom, Germany and the United States that helps companies and cities disclose their environmental impact. CDP scores alphabetically, but Bloomberg converts the rating from 1-10. The higher the number, the better the company has performed.
The MSCI ACWI Index (net) is a free float-adjusted market capitalization-weighted index that measures equity performance of developed and emerging markets. The MSCI ACWI SRI Index (net) includes large and mid-cap stocks across 23 Developed Markets (DM) countries and 27 Emerging Markets (EM0 countries. The index is a capitalization weighted index that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts. Constituent selection is based on research provided by MSCI ESG Research.
IMPORTANT RISK CONSIDERATIONS
Investing involves risks and the possible loss of principal. This report is based on the assumptions and analysis made and believed to be reasonable by the Adviser. However, no assurance can be given that the Adviser’s opinions or expectations will be correct. This report is intended for informational purposes only and should not be considered a recommendation or solicitation to purchase securities.
Equity Securities: The market price of equity securities may be adversely affected by financial market, industry, or issuer-specific events. Focus on a particular style or on small or medium-sized companies may enhance that risk. Credit & Interest: Debt securities are subject to various risks, the most prominent of which are credit and interest rate risk. The issuer of a debt security may fail to make interest and/or principal payments. Values of debt securities may rise or fall in response to changes in interest rates, and this risk may be enhanced with longer-term maturities. Foreign & Emerging Markets: Investing internationally, especially in emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk. Allocation: Asset allocation does not guarantee a profit or protect against a loss in declining markets.
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