What can social impact factors contribute to credit investing?
What can social impact factors contribute to credit investing?
Social considerations are arguably the relatively uncharted area of ESG – environmental, social and governance – investing.
Governance factors are effectively woven into fund manager investment processes. The environment is now, thankfully, a hugely prominent issue given climate risk and growing political and public attention.
Social is relatively undeveloped by comparison. One reason is that it is more challenging. Investors will often talk about the difficulty of defining, quantifying and measuring social factors, many of which are seen as subjective or contentious.
We don’t subscribe to this view and have developed a set of definable and quantifiable social impact metrics. We think that applying these can both contribute to positive social progress and good investment decisions.
We do not have a huge history of data to draw on, but our analysis, which we review every six months, indicates that incorporating social impact factors will result in a tilt toward non-cyclical sectors and companies with higher credit ratings in aggregate.
As such, it embodies relatively stable, lower-risk characteristics. That seems particularly valuable on a long-term perspective and with the additional attraction of supporting positive social outcomes or progress.
Defining and quantifying social impact credit
Social most often relates to people or “human capital”. Our eligible universe is based on the three broad themes: socio-economic inclusion, sustainable infrastructure and health and well-being. Within these we have more specific themes and metrics to measure impact.
These themes encompass or address many challenges and imbalances facing society, such as inequality or the potential to realise productivity through better collective well-being.
The impact of metrics such as number of jobs created, at or better than living wage, or number of people with access to digital communications are self-evident. Being employed is, though, no guarantee of a good standard of living or of quality of employment. So we are also looking for companies which are investing in further learning. Factors such as workforce diversity may yield subtler benefits over the longer-term. Research and development spending likewise may take time before it pays-off.
We want to measure and quantify social investments in a consistent and meaningful way. So, for instance, we measure thousands of people receiving access to mobile connectivity, transportation, social housing or renewable energy, per billion dollars of company market capitalisation or revenue.
Some of the metrics need contextualisation. Access to clean water is more relevant to parts of the world, mostly developing economies, which experience water stress or where people do not have safe drinking water, which affects two billion people globally.
One good example of a social impact company is a Brazilian water and sanitation company. This business was able to significantly increase the amount of people with sewage collection services, and as a result the number of hospitalisations due to water-borne diseases fell by 81% over a nine-year period.
Similarly with diversity of workforce, some contextualisation is helpful. Workforce diversity indicates a healthy company culture. Quite rightly, and encouragingly, companies across industries have adopted targets, and some have made great progress. But there are disparities and it is important to focus in on industries where for instance female participation is low. Investing in and supporting companies doing well in those sectors can perhaps make a greater impact.
Research and development in healthcare likewise could result in a crucial technological advance in medicine or pharmacology, or in transport, but it could take time to develop.
What are the investment characteristics of companies with social impact?
Based on our criteria and methodology, the social impact universe is about 30% of the overall credit universe (using the Bloomberg Multiverse ex-Treasuries A+ to B-). This is after excluding fossil fuels-based energy companies, weapons manufacturers and UN Global Compact and human rights violators.
We review the universe every six months, but what we have observed so far is that companies which score highly on social impact measures broadly tilt towards a higher aggregate credit rating and to non or less-cyclical sectors.
Based on the current social impact universe, a greater proportion of the companies are in the A and BBB+ “buckets”, with a lower proportion in BB+ and lower.
Social impact companies have a slightly lower yield and spread (that is, yield difference with equivalent-maturity government bonds) on average in comparison to the Bloomberg Multiverse. But they have similar duration (a measure of price sensitivity to changes in yields). This could partly be explained by the overall sector composition.
Ranking for social factors, sectors like healthcare, utilities and financials tend to score better. Industrials, consumer discretionary and IT fare worse, partly on diversity or human resource development. Looking at an area like sustainable access to basic infrastructure, this includes “connectivity”, access to telecoms, and affordable renewable energy. These are stable sectors with sticky pricing power.
A lot of the duration in the social impact universe comes from the large component of healthcare companies. They tend to issue longer-maturity bonds, partly because they are regarded as good quality businesses. Duration of bonds from emerging market companies are generally shorter.
A lot of social impact metrics are geared toward long-term outcomes. Diversity of a company’s workforce, the happiness and well-being of its employees or customers and its role to communities/societies may not directly boost the bottom-line in the short-term.
It should, in our view, bolster the intrinsic stability of a business over time, reducing vulnerabilities to regulatory changes, ensuring productivity and longevity of its workforce. A 2018 study from the University of Adelaide Business School has shown companies with more senior female board members are less likely to face environmental lawsuits.
Disclosure of social factors is evolving, but companies which adopt or incorporate social impact targets or “mission” into their strategy tend to provide wider-ranging and more comprehensive disclosure on metrics. This is true across countries and industry sectors.
In financials, many companies qualify on higher training hours for employees, and diverse management. Some would disagree, but this might help to serve a diverse set of customers in a capable, more risk prudent manner, all other things being equal.
Social impact universe offers stability
Policymakers are also looking at social factors and we expect companies with better governance of social intention will be better placed for change. These companies would be better prepared for challenges from shortage of workers, suppliers and customers and their complaints.
The market might take longer to recognise this, although factors such as diversity are already in focus and could attract investors with longer horizons.
In 2021, our social impact universe underperformed in terms of spread moves. But this was possibly due to a broader outperformance for more cyclical sectors and areas benefiting from post-Covid recovery, where social impact qualifiers are slightly underrepresented.
Social impact themes – two examples
Women in Management (promoting gender equality, equal employment and advancement of opportunities for women)
- Background: Limited progress on UN SDG 5 (Gender Equality): “By 2019, women accounted for nearly 39 per cent of the global labour force, but held only 28.3 per cent of managerial positions” (source: UN, https://sdgs.un.org/goals/goal5 )
- 2019 McKinsey study, companies in the top quartile for gender diversity on executive teams were 25 percent more likely to have above-average profitability than companies in the fourth quartile“ (source: https://www.mckinsey.com/featured-insights/diversity-and-inclusion/diversity-wins-how-inclusion-matters)
- For issuers in the top women in management quartile, spread moves during 2021 were less pronounced/volatile than for issuers in the bottom women in management quartile (i.e. spreads tended to be more stable), with average duration a bit shorter in top quartile.
Training and life long learning: “nurturing human capital”
By providing their employees with training opportunities, companies contribute to UN SDG 4 (Quality education). Through expected new skill gains, companies financing training also contribute to the UN SDG 8 (Decent work and economic growth) and UN SDG 10 (Reduced inequalities). The qualitive emphasis for the desired impacts is primarily lower-skilled, less able employees who are most likely to benefit.
Using the “training hours per employee” metric to identify how much on-the-job training companies provide, there was no correlation between credit performance and the social impact score. The distribution of spread changes is similar between the top and bottom quartiles with respect to training and life-long learning.
So for the top quartile the average spread change (for bonds with duration of 2-8 years) was -7.3 in 2021, and for the bottom quartile the spread change was -13.4.
The proportion of bonds downgraded was similar: 16% for the top quartile and 14% for the bottom quartile.
Social impact can improve credit investing
This is still a relatively new area in credit investing and it is hard to draw hard conclusions based on quantitative analysis. We can see that incorporating our social impact criteria results in a tilt towards non-cyclical sectors and to some degree businesses with higher credit ratings.
Amid growing social challenges such as inequality, we think it is vital that companies are attuned to and aligned with social factors and what they can contribute. Those which do this strengthen their licence to operate, standing them in good stead for the long-term.