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Schroders

PRI reporting framework 2019

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You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income

ESG incorporation in actively managed fixed income

Implementation processes

FI 01. Incorporation strategies applied

Indicate (1) Which ESG incorporation strategy and/or combination of strategies you apply to your actively managed fixed income investments; and (2) The proportion (+/- 5%) of your total actively managed fixed income investments each strategy applies to.
SSA
0 Screening alone
0 Thematic alone
0 Integration alone
100 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (financial)
0 Screening alone
0 Thematic alone
0 Integration alone
100 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (non-financial)
0 Screening alone
0 Thematic alone
0 Integration alone
100 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Securitised
0 Screening alone
0 Thematic alone
100 Integration alone
0 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%

01.2. Describe your reasons for choosing a particular ESG incorporation strategy and how combinations of strategies are used.

Our main objective for integrating ESG analysis is to enhance returns and protect value for our clients.

Credit: ESG issues can have a material influence on the sustainability of issuer cash-flows and therefore the risk to bondholders.  We seek to identify and analyse multiple ‘real-world’ themes in a holistic, forward-looking way, and to understand corporate business models to identify how issuers are managing change.  

Sovereigns: Given rapid social and environmental change, it is vital to assess countries' abilities to adapt and thrive as these forces re-shape industries, governments, growth and inflation prospects. We believe ESG integration helps with capital preservation and generating alpha through better country allocation.

Munis: ESG risks are analysed as part of overall security selection, and views incorporated into grades and recommendations.

Securitised: We believe an in-depth understanding of collateral cash flow and structure is the foundation of generating returns in a market where size and complexity leads to exploitable inefficiency. The consideration of ESG factors complements the assessment of the quality of the collateral and the sustainability of the cash flows.

We’re committed to avoiding any companies deriving revenue from cluster munitions or anti-personnel mines. We also manage screened mandates based on client-specific criteria.

01.3. Additional information [Optional].


FI 02. ESG issues and issuer research

02.1. Indicate which ESG factors you systematically research as part of your analysis on issuers.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
Environmental data
Social data
Governance data

02.2. Indicate what format your ESG information comes in and where you typically source it

Indicate who provides this information  

specify description

          Unstructured data
        

Indicate who provides this information  

Indicate who provides this information  

Indicate who provides this information  

Indicate who provides this information  

02.3. Provide a brief description of the ESG information used, highlighting any differences in sources of information across your ESG incorporation strategies.

Our fixed income teams draw upon our ESG specialists’ thematic research, 3P ESG research (e.g. MSCI, EiRIS) and other sources (sell-side research, industry bodies, think tanks, NGOs and academics).  All 3P ESG research we buy is accessible on a central research platform.  We have invested substantial resources to build proprietary tools and databases to ensure that raw ESG data is structured into accessible tools for analysts and fund managers.  The fixed income teams also have regular updates with ESG specialists and ask them to investigate specific issues.

02.4. Additional information. [Optional]

Credit: Each issuer research initiation and credit recommendation update contains a specific assessment of ESG risks. This process is ever-evolving with the development of Schroders’ proprietary ESG tool Context. This framework results in an issuer report on ESG factors identified as most material by the analyst.   Data is sourced directly via annual reports, company websites, and company engagement; 3P ESG data as well as more unconventional data such as Glassdoor and proprietary scores provided by our Sustainable Investment team e.g. SustainEx.

Sovereign: Analysis covers country relevant ESG issues such as corruption and supply chain practices. By assessing the ESG risks and opportunities that have historically driven growth, as well as those that may be influential in the future, it aims to provide investors with a long-term view of countries’ GDP growth as well as an indication as to whether the market is pricing in country sustainability factors across various asset classes.  We draw on a number of databases, in particular those run by NGOs or inter government agencies to source data. 


FI 03. Processes to ensure analysis is robust

03.1. Indicate how you ensure that your ESG research process is robust:

specify description

          We substantiate the conclusions we form from our company engagements with the conclusions reached by our equity colleagues.
        

03.2. Describe how your ESG information or analysis is shared among your investment team.

          Regular meetings of investors with the Sustainable Investment team, as well as the monthly Sustainability investor group meeting
        

03.3. Additional information. [Optional]

Thematic research into ESG issues is another important part of how our ESG specialists add value to the investment process. The team is tasked with identifying poorly understood issues that can fall between the cracks of sector coverage or get overlooked as researchers focus on producing accurate medium-term company or country forecasts.

Credit: Much of the analysis of ESG risks is done by credit researchers at the initiation of a company's coverage. Ongoing identification of emerging ESG issues that can impact the credit is also important as credit researchers assess a company's track record and outlook on this front. This often is the result of collaboration between ESG specialists and credit researchers to derive a better understanding of changing market dynamics. More recently, the team has been utilising a proprietary ESG tool, CONTEXT, which provides a systematic framework for analysing a company’s relationship with its stakeholders and the sustainability of its business model.

Sovereign: Systematic quantitative analysis of social and governance factors are augmented by detailed on-the-ground visits. These will encompass a wide range of engagements with policymakers, politicians and NGOs to assess the short and long-term prospects for an issuer.


(A) Implementation: Screening

FI 04. Types of screening applied

04.1. Indicate the type of screening you conduct.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Negative/exclusionary screening
Positive/best-in-class screening
Norms-based screening

04.2. Describe your approach to screening for internally managed active fixed income

Schroders fully supports the international conventions on Cluster Munitions and Anti-Personnel Mines (APM), and we will not knowingly hold any security that will derive revenue from these sources.  

We also manage some screened fixed income corporate bond funds based on specific client criteria.  

04.3. Additional information. [Optional]


FI 05. Examples of ESG factors in screening process

05.1. Provide examples of how ESG factors are included in your screening criteria.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

The international convention on cluster munitions (the Oslo convention) came into force in 2008, and has subsequently been adopted by various governments within their national legislation. As a result, Schroders has taken the decision to block the purchase of any stock that derives revenue from cluster munitions from our funds globally.

 

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

The international convention on cluster munitions (the Oslo convention) came into force in 2008, and has subsequently been adopted by various governments within their national legislation. As a result, Schroders has taken the decision to block the purchase of any stock that derives revenue from cluster munitions from our funds globally.

 

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

We run segregated mandates which exclude companies involved in some or all of the following activities: tobacco, nuclear, alcohol, adult entertainment and gambling.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

We run segregated mandates with thermal coal exclusions.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

We run a mandate which screens out Iran as per the NYS Iran Divestment Act of 2012, given the country’s link to sponsoring terrorism.

05.2. Additional information.


FI 06. Screening - ensuring criteria are met

06.1. Indicate which systems your organisation has to ensure that fund screening criteria are not breached in fixed income investments.

Type of screening
Checks
Negative/exclusionary screening?

other description

          Internal audit review of screening processes
        
Norms-based screening

other description

          Internal audit review of screening processes
        

06.2. Additional information. [Optional]

We update data on cluster munitions annually. Other screens are run on a quarterly basis. Changes to the list are coded into our dealing system.


(C) Implementation: Integration

FI 10. Integration overview

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

ESG factors are initially addressed at the analyst level and discussed by the team to determine the importance to the stability of future earnings and the resulting ability and willingness of the issuer to meet their interest and principal obligations. ESG factors are then taken into consideration in the portfolio construction process, in particular on the scale and duration of exposure.

While fundamental analysis of individual issuers is important, especially at initiation, we take a thematic approach to ESG issues, conducting proprietary in-depth research on ESG topics and their impact across our holdings. We will draw on granular information sources such as official government statistics on meteorological data, employee turnover or wage trajectories to determine how a factor will impact issuers across countries or sectors. This deep exploration of how external factors will affect an investment ensures that we are capturing broader structural trends across portfolios.

While qualitative ESG factors are difficult to value, we believe these factors contribute to the likelihood of both future financial success and impact inherent risks in the investment. As such, while the more traditional financial indicators form the basis of investment decisions, ESG factors will often impact the size of position, given its impact on the inherent risk to our financial forecasts. We primarily focus on the longer term impact of ESG issues rather than unduly weighting factors which are currently occupying market attention.

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

SSA

ESG analysis is not an objective, it is part of our process. Understanding social and political factors, can give investors better understanding of risk.

We pay particular focus to these issues with our Emerging Market Debt investments. A key part of our process involved on the ground research trips by Fund Managers in these regions. During these we will engage with policymakers, governments, opposition and NGOs. We produce a full report following these trips. They include clear reports on political, social and economic trends and their impact. The reports are also complemented with chart packs covering long-term economic and social indicators to back up this more qualitative analysis. Measurers assessed include freedom of the press, corruption, education, and demographics. In particular we are looking for improvement in the indicators. The final views are then incorporated into our investment decisions.

At Schroders we also integrate ESG into municipal fixed income. A vast majority of municipal projects address environmental, social and community issues.  State and local governments are essential to developing and maintaining both physical infrastructure (water & sewer, bridges, mass transit, roads) & bridges) and social infrastructure (education, health care).  Our proprietary ESG municipal model analyses issuers based on numerous ESG factors, including environmental exposure and social factors, combined with sound financial management and governance.  As with all municipal bonds, careful credit analysis is key to finding value and avoiding potential issues.  Our ESG model is one of the many tools our analysts use to reach a credit opinion on an issuer to unlock value for our clients.

Corporate (financial)

Integrated ESG analysis focuses on a company's capacity to develop valuable products in the future, to maintain cost efficient operations and other activities that will lead to long-run competitive advantages, growth and profitability. Thus we focus on management teams, their track records, their values, and how they employ debt and equity capital, in addition to their product portfolios and profitability. For a company to be a long-term holding in our portfolios we require cashflows that are sustainable in every sense of the word and ESG analysis is central to this work.

Some may argue that it is sufficient to rely on the rating agencies' assessments of these factors. Our experience is that rating agencies largely deal with explicit ESG risks in their most formal manifestations on an ex-post-facto basis, e.g. mandatory regulation, product recalls and consumer boycotts. This often is too late to have a positive impact on our portfolio performance.

Our researchers use a variety of sources: ESG data providers such as Bloomberg and MSCI, data from issuers, governmental bodies, non-government organisations, consultants and academics, as well as work done by think tanks. ESG information is loaded into Schroders' proprietary research platform, Nexus, which shares knowledge across various asset classes.

Much of the analysis of ESG risks is done by credit researchers at the initiation of a company's coverage. Ongoing identification of emerging ESG issues that can impact the credit is also important as credit researchers assess a company's track record and outlook on this front. This often is the result of collaboration between ESG specialists and credit researchers to derive a better understanding of changing market dynamics. We use data gathered by external ESG and credit rating agencies as a reference for our fundamental work in this area, but the final conclusions on ESG impacts are made by our credit researchers.

We have a similar investment process, as described above, for both corporate (financial) and corporate (non-financial).

Corporate (non-financial)

We have a similar investment process, as described above, for both corporate (financial) and corporate (non-financial).

Securitised

We believe an in-depth understanding of collateral cash flow and the impact of the securitised loan’s structure is the foundation of generating returns in a market where size and complexity leads to exploitable inefficiency. The consideration of ESG factors provides a more holistic assessment of the quality of the collateral and the sustainability of the cash flows. Broadly speaking, ESG integration for securitised assets is at the nascent stage; however, we have developed a comprehensive sustainability assessment framework based on five principle pillars. This framework includes both governance (principal/agency conflict) and underlying asset considerations (sustainability). Also, fundamentally embedded within our research is a review of governance, fair lending / predatory lending, and the health of the loan for the consumer. Counterparty considerations are a part of the asset consideration and governance. Additionally, the team has developed proprietary analytics consisting of asset specific models, surveillance and forecast/trend analysis to assist in assessing the sustainability of investment ideas.

10.3. Additional information [OPTIONAL]


FI 11. Integration - ESG information in investment processes

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

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
ESG analysis is integrated into fundamental analysis
ESG analysis is used to adjust the internal credit assessments of issuers.
ESG analysis is used to adjust forecasted financials and future cash flow estimates.
ESG analysis impacts the ranking of an issuer relative to a chosen peer group.
An issuer's ESG bond spreads and its relative value versus its sector peers are analysed to find out if all risks are priced in.
The impact of ESG analysis on bonds of an issuer with different durations/maturities are analysed.
Sensitivity analysis and scenario analysis are applied to valuation models to compare the difference between base-case and ESG-integrated security valuation.
ESG analysis is integrated into portfolio weighting decisions.
Companies, sectors, countries and currency and monitored for changes in ESG exposure and for breaches of risk limits.
The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
Other, specify

11.2. Additional information [OPTIONAL]

Credit

We believe resolutely in the importance of looking past short-term market noise and taking a forward-looking, fundamental research-led approach that emphasises understanding the business models of the issuers of credit, and the challenges they face in the real world that will ultimately determine the success, or weakness of their businesses. 

Analyst recommendations concentrate on these secular forces on demand and supply, and the implications for corporate cash-flows.  The secular influences are what we call our credit ‘themes’, and incorporate the analysis of many environmental and social issues, recognising how acute environmental pressures, and social and political change will have significant impact on supply and demand within an investible horizon.  Themes identify how the world is changing, and enable our credit analysts to determine how adaptable issuers are to change and in turn, the risks to cash-flows and bond-holder value.  Environmental and Social themes (E&S) combine with non-ESG related themes to provide a forward-looking lens through which our analysts judge the sustainability of corporate cash-flows, while Governance (G) issues are critical to assessing idiosyncratic risk at a security level.   As forward-looking investors who seek to deliver value to our customers, we will focus on improvements or deteriorations in these dynamics than just identifying ‘best in class’ based on snapshot metrics. 

Moving from the analysis of ESG factors around the company, the last phase of research is determining intensity of ESG factor trajectories to individual company effects. Our researchers are tasked with identifying potential buckle points in a company’s business model or growth plan with timing and vector (direction and intensity). In many cases, the thematic analysis incorporates ESG perspectives, identifying companies who are benefitting from tailwinds to current business models from a number of secular phenomena. We find that a company’s business model that is anticipating/accommodating multiple sources of secular support gives us greater conviction the default risk will decline; such an assessment, if non-consensus, leads to the portfolio action of significantly overweighting such companies in our portfolios.

This research-led credit approach that integrates E,S and G is applied across a wide range of solutions, including global, regional, benchmarked, unconstrained, total return, income and absolute return. 

Sovereigns

Our sovereign investment process has a different focus from credit investors. Sovereign bond KPIs are measured across the E,S and G using widely reported international survey data. Governance is assessed by, regulatory quality, rule of law, corruption, military expenditure, industrial investment and infrastructure quality. Social stability is examined by assessing unemployment and labour participation, demographics and literacy. On the Environmental side we examine agriculture exposure and commodity imports. This numeric analysis is supplemented by on the ground visits in the local countries to build up a full picture of performance.

At Schroders we also integrate ESG into municipal fixed income. A vast majority of municipal projects address environmental, social and community issues.  State and local governments are essential to developing and maintaining both physical infrastructure (water & sewer, bridges, mass transit, roads) & bridges) and social infrastructure (education, health care).  Our proprietary ESG municipal model analyses issuers based on numerous ESG factors, including environmental exposure and social factors, combined with sound financial management and governance.  As with all municipal bonds, careful credit analysis is key to finding value and avoiding potential issues.  Our ESG model is one of the many tools our analysts use to reach a credit opinion on an issuer to unlock value for our clients

Securitised

We believe an in-depth understanding of collateral cash flow and the impact of the securitised loan’s structure is the foundation of generating returns in a market where size and complexity leads to exploitable inefficiency. The consideration of ESG factors provides a more holistic assessment of the quality of the collateral and the sustainability of the cash flows. Broadly speaking, ESG integration for securitised assets is at the nascent stage; however, we have developed a comprehensive sustainability assessment framework based on five principle pillars. This framework includes both governance (principal/agency conflict) and underlying asset considerations (sustainability). Also, fundamentally embedded within our research is a review of governance, fair lending / predatory lending, and the health of the loan for the consumer. Counterparty considerations are a part of the asset consideration and governance. Additionally, the team has developed proprietary analytics consisting of asset specific models, surveillance and forecast/trend analysis to assist in assessing the sustainability of investment ideas.


FI 12. Integration - E,S and G issues reviewed

12.1. 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

Securitised

Environmental

Social

Governance

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

SSA

Sovereign bond KPIs are measured across the E,S and G using widely reported international survey data. Governance is assessed by, regulatory quality, rule of law, corruption, military expenditure, industrial investment and infrastructure quality. Social stability is examined by assessing unemployment and labour participation, demographics and literacy. On the Environmental side we look at agriculture exposure and commodity imports. This numeric analysis is supplemented by on the ground visits in the local countries to build up a full picture of performance.

 

The $3.8 trillion US municipal market is vital in funding key projects around the country, many of which are an opportunity for ESG focused investing.  After all, a vast majority of municipal projects address environmental, social and community issues.  State and local governments are essential to developing and maintaining both physical infrastructure (water & sewer, bridges, mass transit, roads) & bridges) and social infrastructure (education, health care).  Our proprietary ESG municipal model analyses issuers based on numerous ESG factors, including environmental exposure and social factors, combined with sound financial management and governance.  As with all municipal bonds, careful credit analysis is key to finding value and avoiding potential issues.  Our ESG model is one of the many tools our analysts use to reach a credit opinion on an issuer to unlock value for our clients.

 

Corporate (financial)

We use the same approach when analysing corporate non-financials and financials.

Corporate (non-financial)

We use the same approach when analysing corporate non-financials and financials.

Schroders Credit wants to be the premium risk adjusted performance provider to our customers, and earn their trust.  It is imperative that we anticipate, innovate and commit ourselves to research to identify opportunity and navigate risk in this highly competitive industry. 

We believe resolutely in the importance of looking past short-term market noise and taking a forward-looking, fundamental research-led approach that emphasises understanding the business models of the issuers of credit, and the challenges they face in the real world that will ultimately determine the success, or weakness of their businesses. 

Research is critical to our success. 

Many of our competitors will place emphasis on macroeconomic drivers of the credit cycle to determine value and risk.  Consequently, environmental, social and governance considerations have to be ‘bolted on’ to these processes.  We see the world as a more complex ecosystem. For companies to flourish, they must anticipate multiple external forces shaping supply and demand.   It is important to not only emphasise idiosyncratic research, but anticipate these external forces.  We must use this understanding to contextualise research in a forward-looking way. We integrate E,S and G analysis into the very fabric of our approach and not just  ‘bolt it on’. 

Secular environmental and social/demographic issues are identified at a thematic level together with non-ESG related themes and provide our team of credit analysts with a forward-looking,  non-market related, real world context through which they view fundamental credit analysis.  We draw on granular information sources such as statistics on meteorological data or wage trajectories to determine how factors can impact issuers across countries or sectors.  Analysts also work together closely to understand the knock-on effect across the supply chain – which we feel is an important feature as this is often the most under-researched.  

Credit analysts will judge the potential for companies to adapt to changing secular themes and the effect on their cash-flows.  We assess how companies are adapting by examining data around  employee turnover, training budgets, changing product specifications due to environmental concerns  at a security level yet which in our experience can have dramatic impacts on a company’s cash-flow, profitability and leverage.  

Governance issues will tend to be more idiosyncratic than thematic in nature, and seen as a particularly critical part of our credit research.   However, we seek to look beyond the conventional markers of perceived “good governance.”  A strong business plan and philosophy, quality of management, indicators of management versus employee pay, diversity, employee retention and development, assessed through analysis of company data such as employee turnover, training budgets, etc. at the issuer level, help us to take a view on the credibility, future success and growth of the company and of course ability to meet creditor liabilities comfortably[GJ1] . 

Analyst recommendations concentrate on these secular forces on demand and supply, and the implications for corporate cash-flows.  The secular influences are what we call our credit ‘themes’, and incorporate the analysis of many environmental and social issues, recognising how acute environmental pressures, and social and political change will have significant impact on supply and demand within an investible horizon.  Themes identify how the world is changing, and enable our credit analysts to determine how adaptable issuers are to change and in turn, the risks to cash-flows and bond-holder value.  Environmental and Social themes (E&S) combine with non-ESG related themes to provide a forward-looking lens through which our analysts judge the sustainability of corporate cash-flows, while Governance (G) issues are critical to assessing idiosyncratic risk at a security level.   As forward-looking investors who seek to deliver value to our customers, we will focus on improvements or deteriorations in these dynamics than just identifying ‘best in class’ based on snapshot metrics. 

Moving from the analysis of ESG factors around the company, the last phase of research is determining intensity of ESG factor trajectories to individual company effects. Our researchers are tasked with identifying potential buckle points in a company’s business model or growth plan with timing and vector (direction and intensity). In many cases, the thematic analysis incorporates ESG perspectives, identifying companies who are benefitting from tailwinds to current business models from a number of secular phenomena. We find that a company’s business model that is anticipating/accommodating multiple sources of secular support gives us greater conviction the default risk will decline; such an assessment, if non-consensus, leads to the portfolio action of significantly overweighting such companies in our portfolios.

This research-led credit approach that integrates E,S and G is applied across a wide range of solutions, including global, regional, benchmarked, unconstrained, total return, income and absolute return.  

Securitised

A loan’s sustainability is dependent on more than just financial metrics

We believe an in-depth understanding of collateral cash flow and the impact of the securitised loan’s structure is the foundation of generating returns in a market where size and complexity leads to exploitable inefficiency. The consideration of ESG factors provides a more holistic assessment of the quality of the collateral and the sustainability of the cash flows. Broadly speaking, ESG integration for securitised assets is at the nascent stage; however, we have developed a comprehensive sustainability assessment framework based on five principle pillars. This framework includes both governance (principal/agency conflict) and underlying asset considerations (sustainability). Also, fundamentally embedded within our research is a review of governance, fair lending / predatory lending, and the health of the loan for the consumer. Counterparty considerations are a part of the asset consideration and governance. Additionally, the team has developed proprietary analytics consisting of asset specific models, surveillance and forecast/trend analysis to assist in assessing the sustainability of investment ideas.

Principle pillars

Our investment process begins with the identification of fundamental and technical factors that drive performance for both the overall securitised market and specific sectors. The fundamental framework incorporates the five principle pillars of our sustainability analysis; lawfulness, fairness, purposeful, contractual and sustainability. 

12.3. Additional information.[OPTIONAL]


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