The Point

How to use ESG to assess state government bonds

If you’re investing in state government bonds, you’re probably not too worried about default.

But you might be concerned about a potential credit downgrade – which could result in lower demand for a bond and a drop in its value.

Pendal’s income and fixed interest team has a tool to assess the ESG credentials of state governments – which can highlight credit risks that might lead to ratings downgrades.

The index shows how each state is addressing the UN’s Sustainable Development Goals – a list of the world’s biggest problems.

The ACT, Tasmania and SA lead the index, while WA, Queensland and the NT lag, says Pendal ESG credit analyst Murray Ackman.

“People always talk about default,” says Murray. “But that’s not all we’re looking at.

“There would have to be something catastrophic for a state government not being able to service its debt.

“What does have an impact on your investment is credit downgrades.”

What Sun Cable’s collapse means for renewable investing

What does the collapse of the ambitious Sun Cable solar project say about investing in renewables?

Backed by Atlassian’s Mike Cannon-Brookes and Fortescue’s Andrew Forrest, Sun Cable had grand plans to supply electricity to Singapore from a vast solar array in the Northern Territory.

But the pair disagreed over the method of export – undersea cable versus green hydrogen and ammonia – and the venture is now in voluntary administration.

“The main takeaway is that Sun Cable collapsed over a dispute about exporting – not over the idea of a huge solar array in the NT,” says Pendal ESG credit analyst Murray Ackman.

But it raises questions about a potential Australian energy export industry and the role of green hydrogen.

“Historically, governments and private entrepreneurs are typically best placed to carry the risk of these types of early-stage innovations,” he says.

“For most investors, it’s too early to be going all in on hydrogen.”

Could polluting companies be forced to pay a climate tax?

War, floods and China policy changes pushed this year’s COP27 climate change conference off the front pages.

But there was one thing investors should note, says Pendal Credit ESG analyst Murray Ackman.

COP27’s main achievement was an agreement that bigger polluting countries would compensate developing countries for the effects of climate change.

Some are now calling for this same logic to be applied to companies. 

“This has obvious implications for investors,” says Murray.

“If the logic is high emitters bear responsibility for mitigating the impacts of climate change, this adds credit risk.”

ESG: Fixed interest investors can make the world better too

Sustainable investors should expect fixed interest managers to engage with bond issuers, just as equity managers do with companies, says Pendal credit ESG analyst Murray Ackman.

Engagement refers to dialogue between investors and investees that seeks to improve policies or public disclosure on social, environmental and governance matters.

But it’s not just for equity investors.

Since large parts of the market are unlisted, fixed interest investors are discovering they have a critical role driving change at some of the world’s most important companies.

“Look at the biggest players in the climate transition — most of the utilities, many of the infrastructure owners — they are not listed entities,” says Murray.

“But they issue debt — so we have access to influence them.”

Pendal’s Income and Fixed Interest team has undertaken 73 engagements so far this year.

ESG: Beware the ‘brownium’ penalty

With high energy prices and oil and gas company revenues soaring, shouldn’t the big fossil fuel companies be outperforming in credit and equity markets?

In a pre-ESG world the answer would be ‘yes’.

But now big fossil fuel-based companies are paying a ‘brownium’ penalty to raise money in fixed interest markets — and are trading on lower earnings multiples in equity markets compared to previous years, says Pendal ESG credit analyst Murray Ackman.

“Bond people don’t tend to like taking as much risk,” says Murray. “And bond investors look at the downside risk of ESG as pretty significant.

“In the bond world, an investor could feel uncomfortable buying some energy bonds and holding them til maturity because the world in seven years or so will be very different.

“What if there’s a sudden policy change that no one saw coming?

“Pricing can be severely affected, and you don’t want to get stuck with a bond that you don’t want until maturity.”

Russia ‘self-sanctions’ are a coming of age for ESG

“Self-sanctioning” of Russia by brands such as McDonalds and Apple shows ESG is now a fundamental aspect of investing says Pendal ESG credit analyst Murray Ackman.

The voluntary sanctions demonstrate that society expects business to step up and take its environmental, social and governance obligations seriously, says Murray.

“Going forward, it’s going to be a lot harder for companies to pick and choose their ESG concerns.

“What’s interesting about Russia is that everyone is being called to account – by their investors, by their customers and by society – and asked to explain their exposure to anything Russian-related.

“This represents a normalisation of ESG.”

Taking an ESG approach to investing will help investors avoid this kind of risk in the future, says Murray.

“How do you predict an invasion? Can you forecast when a war will happen? An ESG approach to investing is basically the only alternative.”