Hermes seeks ESG alpha in companies making changes
April 2021 | Issue 233
Dan Alderson
Deputy editor
Buy-side demand to tick boxes for ESG standards has fuelled a boom in green and social impact bonds that is extending into high yield issuance. But as investment opportunities mount, so does soul-searching about the next phase.
Five European high yield borrowers — Via Celere, PPC, Faurecia, Ardagh and Novelis — have hit the primary market this year with green bond issues for a total €1.8 billion. The entirety of 2020 produced less than a quarter of that.
Borrowers have realised they can price tight to non-labelled bonds since so much money is chasing issues. But erosion of pricing, along with questions over borrowers’ intentions (latest issuer, aluminium producer Novelis, refinanced other debt with its €500 million senior note offering) is prompting some firms to dig deeper for ESG prospects.
“As supply builds, this pricing differentiation will be minimised as investors put more analysis into ESG,” says Nachu Chockalingam, senior credit portfolio manager at Federated Hermes. “Bonds such as one we saw lately that are labelled green but used for refinancing are not really what the criteria intend.”
“We see huge differentiation even in sectors that are not obviously ESG compliant”
Nachu Chockalingam, Senior credit portfolio manager | Federated Hermes
Hermes sees the most opportunity not in current leading ESG corporate borrowers, whose securities no longer offer high value, but in the transition leaders of tomorrow.
“These could even be the laggards of today, but have potential to change and are making steps to do so,” she says. “We are seeing huge differentiation even within sectors that are not obviously ESG compliant, such as autos. Spotting these is the best way to capture ESG alpha.”
Europe leads the way on ESG credit criteria, particularly in high yield. On 18 March the European Leveraged Finance Association (Elfa), led by chief executive officer Sabrina Fox, and the Principles for Responsible Investment, led by CEO Fiona Reynolds, launched a second set of sector-specific guidance on ESG disclosures for sub-investment grade corporate borrowers. These support borrowers when preparing ESG disclosure and help them engage with investors.
The high yield part of the market is far behind investment grade on ESG, but it is improving its disclosures, especially in Europe, as investors push for change, says Chockalingam.
“Elfa has played a useful part in this by offering high yield borrowers incentives to increase disclosure, which is then a starting point for conversations about what needs to change.”
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Global credit funds & CLO's
April 2021
| Issue 233
Published in London & New York.
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