Organisation name: Brunel Pension Partnership
Signatory type: Asset owner
Region of operation: England
Assets under management: £30 billion
Why we consider responsible investment principles during manager due diligence
We designed and delivered a multi-asset credit fund for our pension fund clients to meet their demands for diversified exposure to sub-investment grade credit assets. We used responsible investment criteria as part of our due diligence on prospective managers for the mandate.
Being responsible investors in credit is arguably more important than in equities because we – or our managers – are directly providing capital for companies to undertake activities that can potentially be controversial, particularly in the primary market.
How we consider responsible investment principles during manager due diligence
When speaking with portfolio managers about responsible investment, we look at whether they talk about responsible investment in a generic sense, or whether they can demonstrate that they have integrated environmental, social, and governance (ESG) factors into the specific asset class or product they are showing us. We look at their PRI assessment reports; whether they are involved in initiatives such as Climate Action 100+; and ask for examples of engagements specific to the product.
We also consider responsible investment at a fund management company level. We want to see some overlap between our philosophy and the manager’s, as this can be an indicator of how willing they are to form a partnership with us, and the extent to which they will listen if we disagree on an issue. It is important to determine the culture of the company as that helps us to evaluate whether a manager lives out its stated commitments to risk, regulatory and decision-making standards and processes – and its responsible investment principles.
We want to see that managers have assessed the ESG issues that their investee companies face, and that these are taken into consideration when making an investment decision, even if they have a positive view of an issuer’s fundamentals. However, incorporating ESG factors in multi-asset credit strategies comes with multiple challenges, such as data availability and engagement.
Many sub-investment grade firms that issue debt are private and less likely to publicly disclose certain data, such as carbon emissions. Asset complexity compounds this challenge – for example, asset-backed securities or collateral loan obligations can contain 150 – 200 underlying loans, such as individual car loans, mortgages or student loans.
We recognise that it is very difficult to accurately quantify metrics such as the level of carbon intensity arising from an underlying pool of assets. Nonetheless, some managers scored highly in our search process as they were able to demonstrate how they approach this issue of data availability and complexity.
Many credit managers aim to engage with issuers when they refinance their debt but multi-asset credit strategies with high portfolio turnover are less likely to own bonds to maturity and as such, cannot engage that way.
Consequently, we score managers better if they demonstrate that they engage in other ways – for example, some managers held bonds with the same issuers across several products and were able to use this as a route to engagement, even if their multi-asset credit strategy holdings were short term.
Asset complexity can also make engagement challenging, given the number of underlying loans that make up these products. We also score managers highly if they were able to demonstrate that they engage with the CLO or ABS sponsor instead, but we recognise that this approach is in its infancy.
Example: Assessing climate change awareness
As an asset owner, we are committed to reaching net-zero emissions across our investments (including those managed by external managers) by 2050, but as highlighted above, this is difficult in the sub-investment grade credit space.
Was part of our commitment to net zero, we established a climate change policy in 2020 – its key objective is to systematically change the investment industry so that it is fit for purpose for a world where temperature rise needs to be kept to well below 2°C compared to pre-industrial levels. We expect all new mandates, including our multi-asset credit portfolio, to align directly with this, at a minimum.
Our multi-asset credit procurement focused on how well prospective managers integrate climate change considerations into their investment processes, including whether:
- they can determine how aligned their portfolios are to the 2°c-goal of the Paris Agreement by the end of 2022; and
- they aim to reduce their portfolio’s carbon intensity on an annual basis.
As well as meeting these criteria, one manager we assessed was able to demonstrate how they engage on environmental protections with sovereign issuers – a process that can be difficult due to a lack of data and access to public officials. The manager also showed thought leadership by focusing on processes that we are currently unable to put in place ourselves, such as scenario modelling on physical and transitional risk.
The manager in question was ultimately selected to manage part of the multi-asset credit portfolio. We also agreed that the other two managers selected would implement the same methodology to identify industries that were not 2°-aligned. All three managers in the multi-asset credit portfolio now have a clear and consistent view on industries that are not compatible with a 2°-aligned world, and as a result, these are not permitted for investment.