LIM views Environmental, Social, and Governance (ESG) issues as important factors in evaluating industries and issuers. LIM integrates an ESG evaluation into its research process to identify risks that may impact investment performance but which could be overlooked by traditional fundamental credit analysis. Our commitment to ESG is demonstrated by our status as signatory to the Principles for Responsible Investment (PRI) and its statement on ESG in Credit Ratings. We are also a supporter of the Task Force on Climate-Related Financial Disclosures (TCFD) and an affiliate member of Building a Sustainable Investment Community (BASIC).
What is ESG Integration?
ESG Integration is the explicit and systematic inclusion of ESG considerations in the credit research and portfolio construction processes. As an approach, ESG Integration differs from other methodologies in that it does not limit the investible universe by simply excluding sectors or companies with weak ESG profiles.
The integration of ESG into investment decision making has been driven by an understanding that ESG factors can have material financial impacts. For instance, legal, environmental, and labor weaknesses can lead to increased cost of capital, reduced access to funding, and reputational damage. Resource-efficient operations can improve margins. A diverse, independent board can alleviate business risks associated with groupthink.
Why does LIM integrate ESG factors?
The integration of ESG into the credit research process is consistent with LIM’s core philosophy of reducing downside risk and principal preservation. Meeting performance objectives demands that risk be scrutinized for each investment decision. We accomplish this through rigorous, in-house, bottom-up credit analysis.
As fixed income investors, it is our responsibility to understand the risks before investing our clients’ assets. We believe that integrating ESG factors into our research framework enhances our ability to identify areas of vulnerability and opportunity.
How is the process implemented?
LIM’s research team has developed a list of sustainability drivers for each sector that we believe are material to the creditworthiness of specific borrowers. We use this framework to score companies on their performance relative to peers and their level of public disclosure. For example, energy management and employee health and safety are sustainability drivers for a number of industries. A company that manages energy efficiently may exhibit margin expansion and stability whereas a company that ensures the well-being of its employees may avoid extraordinary expenses and contingent liabilities. A lack of independence and diversity of corporate governance can highlight potential risks at the leadership level. The magnitude of these risks must be weighted based on sector-specific considerations.
This added scrutiny also helps us identify corporate trends and management progress in improving sustainability practices. We believe the integration of ESG into corporate credit analysis has served as a valuable enhancement to our research process.
For more information on how LIM integrates ESG into its research process, please see ESG Intergration in Corporate Credit.