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You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income » (C) Implementation: Integration

(C) Implementation: Integration

FI 11. Integration overview

11.1. Describe your approach to integrating ESG into traditional financial analysis.

ESG criteria forms a part of the evaluation of credit investment opportunities. The impact of ESG will vary depending on the type of debt issuer, the industry sector and geographical footprint, as well as the type of instrument and the intended holding period. As such, the integration of ESG criteria in the investment process is based on consolidated views of the relevance of these criteria at country, sector and issuer level, with the judgement of its implications left to the portfolio manager.

Details of the individual approaches are described below

Corporate Governance Team and Credit Analysts and Managers

  • To augment the top-down and bottom-up ESG incorporation, the in-house corporate governance team works closely with credit analysts and portfolio managers.
  • This internal collaboration, which is both through formal mechanisms or via informal discussions, between the teams depends on the investment mandates and may be at the point of portfolio construction, but more frequently it is when a particular issue is identified that is material to the portfolio management team.
  • Information on company meetings is shared, to allow the credit analysts to incorporate this into their views and there is an open invite to most issuer engagements.

ESG Proprietary Scoring tool

  • LGIM's ESG proprietary scoring tool is used to assess ESG risks across the investment universe. It has been in place since 2013. To objectively assess ESG performance relative to peers in the same sector, we have incorporated external data and analysis from six different sources. Each of the environmental, social and governance categories are broken down into relevant subcategories. In turn, each of these subcategories are weighted according to their potential to impact company performance. The overall score for a company's ESG performance is an aggregation of the weighted scores for each subcategory.
  • This score supplements the fundamental assessment of corporate issuers - analysts use the scoring tool as a flagging mechanism to highlight areas of ESG risk and performance that may need to be investigated further, either in company/issuer meetings or through qualitative research. Naturally, the impact of ESG risks is dependent on the type of corporate issuer, it’s balance sheet strength and corporate structure, its industry sector, its geographical footprint and the type of instrument and the intended holding period. Therefore, the integration of ESG criteria in the investment process is based on consolidated views of their relevance.
  • The score is available on the credit analysts and portfolio managers’ Bloomberg platforms.
  • Qualitative research is carried out either by the credit analyst or, where more specialist knowledge is required, the ESG analyst/corporate governance team will work with the credit analyst. Analysts maintain a fundamental rating for each company, based on financial strength and industry outlook, influenced by the overall macro view. ESG risks and performance may influence this. ESG factors may also be incorporated into a company’s cashflow forecast and considered when formulating a view on its overall risk profile.

 ESG Thematic Working Group

  • The ESG Thematic Group is part of new management process to assist the investment teams in considering ESG issues. The ESG Thematic Group is chaired by LGIM's Head of Sustainability & Responsible Investment Strategy, with oversight from the Chief Investment Officer and has representatives from the fixed income and ESG team, as well as other participants from across LGIM.
  • The ESG Thematic Working Group has annual targets, including those related to further supporting integration into the investment process. The Group reports regularly to the LGIM CEO on its progress against those targets.
  • Additionally, participants of the ESG Thematic Working Group have personal targets linked to the success and delivery of the group's goals, as part of their variable compensation.
  • This formal process is driving an LGIM-wide focus on the integration of ESG across all functions of the business, including traditional financial analysis.

Thematic Working Groups

  • LGIM has developed a process to identify and research long-term thematic issues that will shape our investments in the long-term.
  • Three separate working groups have been set up internally during 2017 to understand longer-term insights that may impact LGIM's investments. The first themes reviewed are Technology, Energy and Demographics.
  • The working groups draw on expertise across LGIM, including credit, equity, multi-asset, real asset and ESG professionals. The process is led by LGIM's CIO.
  • As part of the working groups, bespoke research projects under sub-sectors and trends of each theme are being conducted by internal analysts and incorporated into the findings. The working groups use information from a range of sources including external ESG sources, sell-side specialists, service providers and NGO data sources in addition to primary research.
  • The groups meet either weekly or bi-weekly and have produced a number of thought pieces over the course of 2017, outlining our views and the investment implications for our clients. These can be found at: www.lgim.com/thoughtleadership.

All our thematic work was presented at LGIM’s inaugural institutional client conference, held in November 2017. The groups will continue their work over the coming years.

11.2. Describe how your ESG integration approach is adapted to each of the different types of fixed income you invest in.

SSA

Integration of ESG into SSA is done at a top-down and bottom up level.

  • At the top down level, this means allocation to regions and countries is based on the evaluation of economic, governance and socio-political risks by our in-house economists, credit strategists, credit analysts and portfolio managers. Country-specific ESG criteria captures the performance of previous and current governments and also address the transparency, fairness and consistency of the political, legal  and administrative framework as a whole. Major political parties' prevailing attitudes with respect to ESG issues, including corruption and the respect for private investors' property rights, are also taken into account. As part of this assessment we monitor the role that technology is playing in adjusting political and societal processes, and its subsequent  impact to the governance environment. Exposure and resilience of the economy to environmental phenomenon, such as El Nino/La Nina are also considered.
  • From the bottom up, our analysts covering investment grade sovereign related and sub-sovereign issuers conduct a desktop review of the governance framework applicable to the issuer, its compliance historically with these frameworks and the political risks inherent in the governance framework. The analysts also review the Social and Environmental disclosure of the issuer, including a consideration of its social/environmental mandate where applicable, since many government related entities have specific mandates to invest in local development. This assessment is largely qualitative, and always informed by the economic and political backdrop in the relevant country or countries, and the perceived willingness and ability of the issuer to adhere to its stated policies
  • Examples of how these considerations pass through into the Investment Grade team decision-making process include:  our assessment of Temasek, where the closer relationship between the entity and government has prompted us to re-evaluate the governance assessment and view it as less of an arm's length entity; and NWB - where we are trying to understand the environmental impact of its lending policies and those of its customers, the domestic water boards, in order to determine how critical its function is to the economy and therefore how long dated we want our exposure to be.
  • The Emerging Market sovereign team also draw on a proprietary ESG-linked scoring tool in assessment of country-credit risk. The tool incorporates assessment of multiple ESG-related factors, such as country education levels, access to internet, corruption indices, and income  inequality.
  • Examples of how these considerations pass through into the emerging markets investment team decision-making process include: 1) a structural underweight position in Mozambique that defaulted on its debt in 2016 and has still failed to reach an agreement with investors, 2) a cautious positioning re: Turkish credit, given the political and geopolitical concerns surrounding the country, 3) a return to an overweight position in South African external bonds as it became clear that a government change for the better was upcoming (this included pre-empting ratings stabilisation action), and 4) a tactical increase in exposure to Angolan sovereign debt in anticipation of government reforms to tackle corruption and economic disparities
  • In addition, our ESG thematic working groups provide the opportunity to link ESG themes to both corporate and sovereign credit analysis. Analysts and PMs from across asset classes and investment strategies sit on the working groups, and outputs are shared across the business through our Thought Leadership webpages and internal updates.

Corporate (financial)

We have the same approach for integrating ESG into traditional financial analysis for corporate financials, as we do for corporate non-financials. However, governance has a particularly strong focus for financials, more so than environmental and social considerations.

Corporate (non-financial)

The ultimate responsibility for assessing the materiality of ESG on credit worthiness sits with the credit analyst. However input from other parties is also important. Please see a summary of our methodology, as well as further explanation in FI 11.

11.3. Additional information [OPTIONAL]

In summary, quantitative elements, supplemented by direct company engagements and other external research sources, would ultimately lead to the analysts' recommendations allocated to each issuer. Overall, the integration of ESG-related criteria in the assessment of companies is not intended to result in any negative or exclusion lists. Rather, it aims to enhance our ability to discern between likely outperformers and underperformers within each sector.


FI 12. Integration - ESG information in investment processes

12.1. Indicate how ESG information is typically used as part of your investment process.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
ESG analysis is integrated into fundamental analysis
ESG analysis is integrated into security weighting decisions
ESG analysis is integrated into portfolio construction decisions
ESG analysis is a standard part of internal credit ratings or assessment
ESG analysis for issuers is a standard agenda item at investment committee meetings
ESG analysis is regularly featured in internal research notes or similar
ESG analysis is a standard feature of ongoing portfolio monitoring
ESG analysis features in all internal issuer summaries or similar documents
Other, specify

12.2. Additional information [OPTIONAL]

For High Yield fixed income ESG analysis is featured in ALL internal issuer summaries.

Over the past year this has also increased in investment grade research issuer summaries, ESG features where material or relevant to the investment thesis. .

Company ESG scores systematically feed into research templates and recommendation monitors.


FI 13. Integration - E,S and G issues reviewed

13.1. Indicate the extent to which ESG issues are reviewed in your integration process.

Environment
Social
Governance
SSA

Environmental

Social

Governance

Corporate (financial)

Environmental

Social

Governance

Corporate (non-financial)

Environmental

Social

Governance

13.2. Please provide more detail on how you review E, S and G factors in your integration process.

SSA

As described in section 11, Integration of ESG into SSA is done at a top-down and bottom-up level.

At the top-down level, this means allocation to regions and countries is based on the evaluation of economic, governance and socio-political risks by our in-house economists, credit strategists, credit analysts and portfolio managers. Country-specific ESG criteria captures the performance of previous and current governments and also address the transparency, fairness and consistency of the political, legal and administrative framework as a whole. Major political parties' prevailing attitudes with respect to ESG issues, including corruption and the respect for private investors' property rights, are also taken into account. As part of this assessment we monitor the role that technology is playing in adjusting political and societal processes, and its subsequent impact to the governance environment. Exposure and resilience of the economy to environmental phenomenon, such as El Nino/La Nina are also considered.

From the bottom up, our analysts covering investment grade sovereign related and sub-sovereign issuers conduct a desktop review of the governance framework applicable to the issuer, its compliance historically with these frameworks and the political risks inherent in the governance framework. The analysts also review the Social and Environmental disclosure of the issuer, including a consideration of its social/environmental mandate where applicable, since many government related entities have specific mandates to invest in local development. This assessment is largely qualitative, and always informed by the economic and political backdrop in the relevant country or countries, and the perceived willingness and ability of the issuer to adhere to its stated policies

Examples of how these considerations pass through into the Investment Grade team decision-making process include:  our assessment of Temasek, where the closer relationship between the entity and government has prompted us to re-evaluate the governance assessment and view it as less of an arm's length entity; and NWB - where we are trying to understand the environmental impact of its lending policies and those of its customers, the domestic water boards, in order to determine how critical its function is to the economy and therefore how long dated we want our exposure to be.

The emerging market sovereign team also draws upon his proprietary ESG-linked scoring tool in assessment of country-credit risk. The tool incorporates assessment of multiple ESG-related factors, such as country education levels, access to internet, corruption indices, and income  inequality.

Examples of how ESG considerations pass through into the emerging markets investment team decision-making process include: 1) a structural underweight position in Mozambique that defaulted on its debt in 2016 and has still failed to reach an agreement with investors, 2) a cautious positioning re Turkish credit, given the political and geopolitical concerns surrounding the country, 3) a return to an overweight position in South African external bonds as it became clear that a government change for the better was upcoming (this included pre-empting ratings stabilisation action), and 4) a tactical increase in exposure to Angolan sovereign debt in anticipation of government reforms to tackle corruption and economic disparities.

In addition, our ESG thematic working groups provide the opportunity to link ESG themes to both corporate and sovereign credit implications. Analysts and PM’s from across asset classes and investment strategies sit on the working groups, and outputs are shared across the business through our Thought Leadership webpages and internal updates.

Corporate (financial)

Please see section 11 above for full explanation of our analytical process. We assess each of environmental, social and governance factors through both our ESG scoring tool, and qualitative analysis.

Systemic Quantitative Analysis

  • Systematic analysis occurs at the level of the LGIM's ESG proprietary scoring tool. Our scoring tool allows us to have a snapshot of ESG performance across our investable universe. (In this case, investible universe is defined as where information is available and can be shared with the investment teams (therefore public companies and large private companies))
  • Additionally, with regards to High Yield products, there is a systematically produced analysis of ESG issues for all products. High Yield fixed income investments are often private companies, therefore are either not available on Bloomberg (where LGIM's proprietary ESG score is shared), or there is a lack of public information on the companies’ ESG impact.

Sector Relevance:

  • The tool has identified financially material ESG risks specific to each of the 17 different sectors.
  • Each component of the ESG indicator is weighted according to the potential impact on company performance. This means E,S& G may be weighted differently across sectors, however the weighting takes place systematically.
  • Credit analysts and ESG/corporate governance teams look at these scores before assessing or meeting with a company. Further, it triggers the process of qualitative analysis explained above.
  • The relevance of the weighting of each ESG component on a sector basis are reviewed by the corporate governance and fixed income specialists to ensure the weightings remain relevant and the scores are weighted towards the most material factors for each sector.

Systematic qualitative analysis:

  • The ESG scores are used to monitor a company’s performance within and between the corporate governance and investment teams. This monitoring is supplemented by information gained through company meetings and individual knowledge. We have specific processes in place for sharing this information in a time-relevant manner.
  • When an issuer is being reviewed by the credit analyst, consideration will be given to their previous ESG risk profile, and depending on timing, a review of this profile will be carried out. The review may input into the fundamental analysis that takes place in monitoring/reviewing securities and portfolios.
  • Again, environmental, social and governance factors will be assessed in accordance with how relevant each is to the sector in terms of material impact, and dependant on company qualitative performance.

LGIM Wide ESG Thematic Group and Thematic Working Groups

  • As mentioned above in section 11, the Thematic Working Groups are further reviewing the relevance of ESG and long-term thematic issues. The first issues to be reviewed include Energy, Demographics and Technology.
  • The ESG Thematic Group has annual targets related to ESG KPIs and reports directly to LGIM’s CEO. The group, comprising members from fixed income, equities, multi-asset, solutions and the Corporate Governance team, works to embed ESG throughout the organisation.

Corporate (non-financial)

We take the same approach to corporate financials credit as to corporate non-financial.

Systemic Quantitative Analysis

  • Systematic analysis occurs at the level of the LGIM's ESG proprietary scoring tool. Our scoring tool allows us to have a snapshot of ESG performance across our investable universe. (In this case, investible universe is defined as where information is available and can be shared with the investment teams (therefore public companies and large private companies))
  • Additionally, with regards to High Yield products, there is a systematically produced analysis of ESG issues for all products. High Yield fixed income investments are often private companies, therefore are either not available on Bloomberg (where LGIM's proprietary ESG score is shared), or there is a lack of public information on the companies’ ESG impact.

Sector Relevance

  • The tool has identified financially material ESG risks specific to each of the 17 different sectors.
  • Each component of the ESG indicator is weighted according to the potential impact on company performance. This means E, S & G may be weighted differently across sectors, however the weighting takes place systematically.
  • Credit analysts and ESG/corporate governance teams look at these scores before assessing or meeting with a company. Further, it triggers the process of qualitative analysis explained above.
  • The relevance of the weighting of each ESG component on a sector basis are reviewed by the corporate governance and fixed income specialists to ensure the weightings remain relevant and the scores are weighted towards the most material factors for each sector.

Systematic qualitative analysis

  • The ESG scores are used to monitor performance within and between the corporate governance and investment teams. This monitoring is supplemented by information gained through company meetings and individual knowledge. We have specific processes in place for sharing this information in a time-relevant manner.
  • When an issuer is being reviewed by the credit analyst, consideration will be given to their previous ESG risk profile, and depending on timing, a review of this profile will be carried out. The review will input into the fundamental analysis that takes place in monitoring/reviewing securities and portfolios.
  • Again, environmental, social and governance factors will be assessed in accordance with how relevant each is to the sector in terms of material impact, and dependant on company qualitative performance.

LGIM Wide ESG Thematic Group and Thematic Working Groups

  • As mentioned above in section 11, the Thematic Working Groups are further reviewing the relevance of ESG and long-term thematic issues. The first issues to be reviewed include Energy, Demographics and Technology.
  • The ESG Thematic Group has annual targets related to ESG KPIs and reports directly to LGIM’s CEO. The group, comprising members from fixed income, equities, multi-asset, solutions and the Corporate Governance team, works to embed ESG throughout the organisation.

13.3. Additional information.[OPTIONAL]


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