Standing out among the crowd

IN A world where integration of ESG (environmental, social and governance) factors into the investment process is increasingly mainstream, how would a fund differentiate itself or outperform its peers?

J Safra Sarasin Sustainable Asset Management pursues a strategy that it believes will help it to identify opportunities with the largest upside potential in the fixed income universe.

This is through a two-pronged approach: A ''worst out'' method which eschews issuers with the worst ESG ratings, and investing in ''rising stars'' or those which may not be best-in-class in ESG terms today, but show signs of significant improvement.

This approach applies to its total return strategy, defined as a flexible, global and non-benchmarked approach to fixed income. The JSS Sustainable Bond - Total Return Global is open for accredited investors. Based on the May fact sheet, 55 per cent of holdings have a credit rating of AAA.

The firm says it is a pioneer in sustainable investments, having developed a proprietary research and investment framework over more than 30 years. Its first dedicated mandates with environmental criteria were rolled out in 1989.

The J Safra Sarasin Group manages a total of 192.4 billion Swiss franc (S$280.3 billion) in assets, including wealth and asset management.

Stéphane Decrauzat, the firm's head of total return fixed income, says the most pivotal change through the years was the increasing availability of a wealth of ESG data. ''Having more ESG data and deeper granularity allow investors to better assess the impact of various factors for different issuers across a broad range of sectors. In addition, although the majority of ESG research papers initially focused on equities, more research has been produced recently in the fixed income space to address... solvency issues or credit risks associated with ESG factors.''

As with any fixed income investment, the starting point is a focus on downside risks. This includes assessment of interest rate, credit and other risks that may impact an issuer's ability to repay debt or may negatively impact a bond's price.

The firm's sustainability analysis produces two scores - company ratings and industry ratings - which are combined and displayed in a proprietary ''Sarasin Sustainability Matrix''. This produces a graphic representation of both the ''worst out'' or C-rated issuers to avoid and the ''best-in-class'' (A-rated) as well as those which fall into a middle category or B-rated. There is a fourth D rating, comprising companies with controversial business activities. Avoiding categories C and D enables the firm to refine its investable universe.

Wernhard Kublun Becerra, investment specialist (fixed income), says: ''... we prefer holding a double- B rated issuer that is on an improving trajectory, and a possible candidate for an upgrade to triple B. The improving credit quality of the issuer should drive credit spreads to fall, which results in higher valuations. We believe the same principle applies to sustainability, where an improvement in an issuer's profile should over time translate into tighter credit spreads and lower risk premiums... We believe an improving ESG profile will most definitely have a positive impact on the credit profile and thereby the valuation of an issuer.''

In the total return portfolio, about 38 per cent is A-rated for ESG and the balance is B-rated. In environmentally exposed sectors such as oil and gas and materials, issuers must achieve a relatively high company rating in order to make it into the ''bestin- class'' investable universe. For such industries, the key performance indicators (KPIs) behind the environmental pillar will have a higher weight than social and governance.

Mr Decrauzat says the matrix also helps the team to identify long-term sustainable trends which are then incorporated into the investment process. ''From a bottom-up perspective, we combine the ESG insights with all other financial data to have a more comprehensive or holistic view of an investment case.

''Ultimately, the matrix helps us in mitigating risks that are typically underestimated during the capital allocation or valuation process, such as environmental, legal and reputational (risks). At the same time it helps in selecting the enterprises with better growth prospects, better governance and hence more viable issuers.''

After an investment is made, targeted engagement may ensue. The firm participates in collective engagements by joining other investors in dialogues with companies on ESG issues.

European utilities are examples of how a wealth of ESG data underpins analyses. In terms of environmental aspects, the firm considers four key issues: Carbon emissions, water stress; toxic emissions and waste; and opportunities in renewable energy.

Mr Becerra says several European utilities score well on the key issues and remain on a positive trajectory. But at the same time, utilities is a strategic sector for countries, which can result in a concentrated market with some form of state control. This could raise challenges in terms of the governance aspects of utilities.

''What is important is for a portfolio manager to first understand a company's strengths and weaknesses, as well as risks and opportunities. This is where a tight collaboration between the portfolio manager and our ESG analysts adds value, bringing deeper and actionable insights about the relevant key issues.''

The total return strategy is currently invested in some bonds issued by European utilities that make above-average efforts (vs the sector) to mitigate their carbon footprint. This gives the team confidence that the investment case and valuations should develop positively.