22 February 2021
Environmental Finance spoke with investment management firm Brown Advisory to see how its approach to sustainable fixed income has changed through the lens of the pandemic. Amy Hauter and Lisa Abraham discuss which investment factors arose and demonstrate how various bond issuers in their portfolios rose to the occasion to generate a positive impact during a challenging time
Environmental Finance: From your perspective, how did the sustainable fixed income universe respond to the pandemic?
Amy Hauter, CFA, portfolio manager and head of sustainable fixed income, Brown Advisory: We break the sustainable fixed income market into three categories: labelled bonds (this includes green, social, sustainability and other labelled bonds), targeted use of proceeds (also known as unlabelled bonds), and "impactful issuers," meaning issuers that are generally positive contributors via their business model or operations. We found compelling opportunities in 2020 in all three of these categories, and generally saw the sustainable bond space thrive during the pandemic.
For labelled bonds specifically, we saw tremendous growth in 2020. The global green bond market exceeded $1 trillion in total cumulative issuance and when one takes social and sustainability labelled debt into account, that number exceeded $2 trillion, according to Bloomberg.
Social and sustainability bonds gained popularity as issuers sought to address some of the social challenges presented by the pandemic. This included direct expenditures for Covid-19 relief efforts, as well as proceeds used to address some of the underlying racial disparities laid bare by the pandemic.
We also saw that despite pandemic-related disruptions, governments, corporations, and investors remained focused on addressing climate change and contributing to the continued growth in the green bond market.
EF: The pandemic has resulted in unprecedented economic disruption as well as an historic market downturn. What environmental, social and governance (ESG) risks emerged, or grew more concerning, during the pandemic?
AH: There is an inherent asymmetry to bond returns – upside potential is limited while downside risk in the event of default is significant. So managing downside risks is very important to us, and we find ESG research to be very valuable as a complement to fundamental research in thinking about those risks. ESG information helps us make better decisions, especially during periods of extreme volatility as we saw last year.
We generally focus on ESG issues we think are material to an issuer's long-term health and prosperity, such as employee treatment, customer care, health and safety, and other responsible management practices. These factors are always meaningful for companies, but the global pandemic greatly amplified their importance.
Specifically, we were very focused on three key ESG risks:
- Employees – how our holdings were managing employees and prioritising their health and safety relative to the pandemic.
- Customers – how our holdings were managing relationships with customers (for example, consumer lending companies and how they handled borrowers whose incomes were interrupted).
- Society – how our holdings were innovating to find solutions to fight the pandemic and provide aid to vulnerable communities.
While sending employees home, closing stores, waiving fees and charges may have decreased a firm's earnings in the short term, we believe that those actions often positioned companies well for the future through stronger employee morale, customer loyalty, and brand value. Further, companies that found a role in addressing this crisis provided the kind of impact we look for, and in some cases may have opened up new long-term business opportunities.
EF: Did sustainability factors make a discernible difference in investment results during this period?
AH: In general, we found that the issuers focused on the long-term success of their business did better. These are the same kinds of companies that also focused on issues like climate change, energy usage, treating customers and suppliers fairly, etc.
Asset-backed securities (ABS) issuers are a good example. Some are focused on gathering loans and selling them quickly to investors to offload risk and lock in profits. Others use the ABS market as a funding tool but are focused on running a sustainable business for the long-term.
The pandemic showed that the second set of issuers were doing better underwriting, but also focused on maintaining good relationships with both their customers and investors during a rough period. That is the kind of firm any investor should want to do business with, and we look to lend to these types of issuers. These are the same issuers who came out on top during this period.
EF: Has Covid-19 influenced your engagement discussions with bond issuers?
Lisa Abraham, senior ESG fixed income research analyst, Brown Advisory: Yes, many of our conversations with issuers revolved around how they were addressing the pandemic and balancing the needs of multiple stakeholders. We recognised that the pandemic is an unprecedented situation and there is no singular engagement ask that applies to the many different issues that arose for companies and issuers in 2020.
Nonetheless, it was important for us to engage with management teams to understand how they were managing any near-term risks but also to see how they reacted in times of crisis, which can serve as a helpful data point for us assessing long-term ESG risks and opportunities. This was particularly important for our ABS holdings (as noted earlier), as well as our mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS) holdings where the underlying loans were to low-income or otherwise underserved communities that experienced disproportionate job losses and financial distress from the pandemic.
Given this exposure to more vulnerable populations, it was important for us to engage with the issuers to understand and evaluate what the programs lenders were putting in place to help borrowers reschedule payments or otherwise avoid default. Robust programs, in our view, will benefit borrowers and lenders in the long run.
EF: How did lenders generally conduct themselves with respect to loan terms/forgiveness/etc.?
LA: In general, because we have always looked for a strong alignment of interest between lenders, investors, and the end borrowers, we were pleased to see that many issuers were quick to react and were working with borrowers that were experiencing hardship.
In our ABS portfolio, we invest in Oportun (a community development finance institution) and Freedom Financial (a consumer lender focused on helping customers already facing some financial hardship). Both of these investments are not labelled bonds but fall under the impactful investor category.
We were pleased to see them implement flexible deferment policies, working with borrowers that were experiencing hardship.
In our MBS and CMBS portfolio, Fannie Mae and Freddie Mac implemented a suspension of foreclosure sales and evictions for single family housing, and grants of forbearance for multi-family property owners with the requirement that they suspend evictions of any tenants facing Covid-19-related hardship.
We viewed these measures as largely positive for all parties involved; if stressed borrowers are given more time to get current on their payments, fewer of them would be forced into default, which can destroy long-term value for bondholders.
EF: Can you tell me about the direct positive impacts generated by your portfolio holdings, and how they have contributed to fighting the pandemic?
LA: In fixed income, we have the ability at times to address societal challenges from multiple angles. For example, we are invested in several hospitals that were on the frontlines of addressing the pandemic – some directly caring for and treating patients, and others driving treatment research.
A good example is the University of Pittsburgh Medical Centre (UPMC). An international team led by scientists at UPMC pooled data from 121 hospitals in eight countries to find that widely available steroids improved the odds that critically ill Covid-19 patients will survive the illness. Between March and June, a randomised trial found that giving Covid-19 patients in intensive care a seven-day intravenous course of hydrocortisone led to a 93% chance of better outcomes than not giving the steroid. According to the University of Pittsburgh, the results were consistent across age, race and gender.
For corporates, we were exposed to companies that were key to the development and rollout of screening and treatment. One example to highlight is CVS, the pharmacy and healthcare provider. We have been invested in CVS for a while and we were impressed by CVS' reach and ability to provide access to affordable healthcare around the country.
According to CVS, more than 50% of Americans live within ten miles of a CVS MinuteClinic, and services provided at MinuteClinics can cost up to 90% less than at urgent care centres or emergency rooms. More and more, we saw how CVS was evolving into a one-stop shop for all healthcare needs.
We found that CVS' reach and versatility helped it to quickly respond at the onset of the pandemic by quickly setting up testing sites in parking lots. And now, we are seeing the company play a critical role in vaccine distribution. It was announced at the JP Morgan Health Care Conference that, as of mid- January, CVS was responsible for 10% of vaccines administered in the US to that point, primarily in long-term care facilities. They expect to ramp this up and will be able to administer 20-25 million vaccines per month once the vaccine becomes more widely available.
Finally, through supranationals like the World Bank, we were able to help ensure that developing countries also have access to the necessary resources to fight the pandemic.
At the onset of the pandemic, the International Bank for Reconstruction and Development (part of the World Bank Group) issued $8 billion in financing for Covid-19 emergency health support in low- and middle-income nations, as part of a $160 billion World Bank Group Covid relief program.
The World Bank states that this programme includes training and supporting front-line health care workers, provides PPE and portable ventilators, and other vital medical equipment and builds or expands clinical care facilities. We thought all these initiatives were very important.
It was very inspiring for us to see many of our holdings rise to the occasion and play their role in fighting the pandemic.
EF: Do you expect labelled bond issuance to continue its rapid growth trajectory, or might it pause if the immediate covid threat recedes?
AH: We expect the momentum to not only continue but also to accelerate. The Covid-19 pandemic served as a proof point of why we need to focus on some of the "S" factors that may have been previously overlooked. As a result, we expect to see more social and sustainability bonds being issued.
We also expect to see a heightened focus on climate change. We saw many companies and governments double down on their commitments to address climate change. In 2020, we saw Japan, South Korea, and Canada commit to net zero by 2050, and China net zero by 2060. We also saw large corporations like General Mills, Facebook, BP and Shell make net zero by 2050 commitments.
While this is an encouraging first step, we know that these commitments will need to be followed with significant investment in order to achieve these goals, and we believe the fixed income market is going to play a central role in financing that.
In a way, the pandemic has led us all to reflect and reimagine what "normal life" should look like, and we think the continuing momentum in the sustainable fixed income markets will show that.
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