Multi-Sector Credit: Making an impact with a focus on valuation anomalies

Not a one size fits all solution

Impact strategies were originally created for private market investors or those looking for an allocation to issuers with widely accepted sustainable products, services, or operations. With that said, impact solutions come in many iterations to achieve their sustainable objectives. Some are pure green bond funds, others may come in the form of best-in-class positive tilt funds, or thematic funds. A strategy rooted in broad based exclusions could mean excluding certain sectors based on ESG considerations alone at the cost of investment value. Broad sector exclusions are not always the answer, although many current and prospective clients are interested in negative screens.

As an example, nuclear energy producers have been subjected to broad investor exclusions. Now that nuclear energy is experiencing a renaissance, investors that maintain these exclusions may lose out on potential upside. These exclusions sometimes overcompensate for short-term sentiment rather than account for a long-term structural view. The same thinking also applies to the metals and mining sector. This industry is on the precipice of innovation, and we feel that broad exclusion would be a disservice to our process and to our clients. Accessing the full investment universe allows us to keep to our value philosophy and helps us to create impact across a variety of sectors.

In order to fund the transition to a more sustainable economy, and to make a greater impact, investing and engaging with those harder to green sectors will be vital. For example, the largest emitting sectors in the Bloomberg Aggregate Corporate Bond Index include utilities, energy, materials and industrials (Exhibit 1). By excluding some or all of those sectors, investors are not only limiting their investment universe and their ability to sector rotate, but also their ability to make an impact in those sectors, whether it be environmental or social. Instead, by actively engaging with issuers in these sectors and guiding them along a sustainable pathway, their impact spans a wide array of sectors and potentially the ability to significantly lower carbon emissions.

The synergies of impact investing and a multi-sector framework

Our Global Multi-Sector Credit Impact strategy is designed to capitalize on investing in and engaging with fixed income issuers that show improvements on environmental and social practices.

The impact framework identifies issuers and sectors that need to develop plans to improve upon sustainability risks, which may not be reflected in valuations. One of the main tools used to implement this process and drive change within our impact focused fixed income strategies is leveraging engagements. Through engagements, we can work with issuers to develop strategies to manage downside ESG risk and unlock value. Examples of sustainable pathways could include adopting climate mitigation practices, preserving and protecting the environment, or reducing inequality.

After identification, specific key performance indicators (KPIs) are set to target and measure sustainability progress along these pathways and the effectiveness of their engagements. For example, KPIs for a Net Zero Alignment pathway could include emissions of inorganic pollutants, emissions of air pollutants, and missions of ozone depletion. A holding will be divested if a particular KPI does not reflect improvement or if an issuer has not implemented a policy to address existing sustainability risk.

In addition, the investment process incorporates macroeconomic themes and valuation analysis across the broad fixed income investment universe – including global investment grade, global high yield, emerging market debt and more. Macroeconomic country and currency perspectives are combined and incorporated with fundamental analysis in determining sector allocation and issue selection. Fundamental research is grounded in evaluation of business model (and cash flows), specific issuer bond covenants, recovery rate, and position in the capital structure. The aim is to identify sectors and issuers that offer greater yield and total return potential with lower risk.

Based on our experience managing multi-credit strategies, we believe a multi-sector credit approach which combines an impact framework with a focus on valuation anomalies has the potential to provide the strongest risk adjusted outcomes, whilst green bonds or other strategies with a focus on “best in class” may overlook value opportunities to reach their impact goals and sacrifice performance as a result of this. (Exhibit 2)

Supplemental information to the Global Multi-Sector Impact GIPS composite presentation.  Data is obtained from Morningstar Direct and is believed to be reliable and accurate and is included for informational purposes only. The metrics shown are only one component of performance and are not and should not be viewed as a statement of the future performance of the strategy. There is no guarantee that holding securities with any of the risk metrics shown will cause the portfolio to outperform its benchmark. Indices are unmanaged and are not available for direct investment. Performance results of the named strategy are presented net of management fees. Net performance returns of the named strategy reflect the deduction of all applicable management fees and expenses, before custody charges, withholding taxes and other indirect expenses. Net performance returns over one year are annualized and assume the reinvestment of all dividends, interest, and capital gains.  As fees are deducted quarterly, the compounding effect will be to increase the impact of fees by an amount directed related to the gross account performance. Please refer to the GIPS® performance presentation, which include net performance, performance footnotes, fee schedules, detailed index descriptions, and disclosures. Indices are unmanaged and are not available for direct investment. The Global Multi-Sector Impact strategy is not substantially similar to the Global Multi-Sector Income Composite. The Global Multi-Sector Impact strategy has no performance history, and the Global Multi-Sector Income strategy performance is being presented to demonstrate the Firm's experience managing other multi-sector portfolios. The Global Multi-Sector Income performance is not representative of the performance of Global Multi Sector Impact strategy or the performance that the Global Multi Sector Impact strategy would have produced if it had been managed during the period presented. Please see Appendix 1 for additional disclosure information. Past performance is no guarantee of future results.

This material was originally published in the Savvy Investor Special Report: Discovering Sources of Alpha and Diversification in Fixed Income: Industry experts discuss opportunities in a transformed fixed income landscape.