Aviva Investors has outlined the importance of environmental, social and governance risks for credit investors over both the short and long term.
The firm said that short-term ESG risks can materialise quickly and often arise from issues such as governance, misconduct or health and safety breaches.
Short-term risks can potentially have a greater impact on short-term investors compared to long-term investors who are able to ride out the crisis or adjust their portfolios in response.
“Sudden scandals can create issues within portfolio management, as money market funds, particularly triple-A rated funds, are constrained by regulators and rating agencies, which might force a divestment,” said Aviva Investors global liquidity portfolio manager Demi Angelaki.
Since money market funds are primarily invested in financials, which usually have a high credit rating and issue more in the short-term market, governance is key according to Ms Angelaki.
“Recent cases like the Archegos scandal, which highlighted governance issues in financials, stress the importance of ESG integration at all stages of investment decision making, including monitoring and engagement,” she said.
“We see it as a tool for downside protection as well as assurance that emerging issues can be swiftly remedied.”
Aviva said that long-term investors have more flexibility when it comes to short-term risks, with a reduction in profit or significant investment in resolving an issue not necessarily having a material impact on credit spread and returns over longer periods.
In contrast to the typical shock of short-term ESG risks, Aviva said that long-term risks are more often created by shifts in technology, regulation and consumer habits.
“Compared to short-term portfolios, credit and buy-and-maintain in particular put more emphasis on long-term thematics that are reshaping the world – the energy transition, technology evolution, healthier living,” said Aviva Investors senior global investment-grade portfolio manager Justine Vroman.
Aviva Investors global head of buy-and-maintain credit Iain Forrester said that understanding long-term ESG risks is an integral part of the buy-and-maintain process.
“The further you look into the future, the less you can rely on quantitative models of a company’s balance sheet and the more weight you have to give to qualitative assessments of how the business will react in the face of long-term trends,” he said.
“These are increasingly coming to bear in terms of companies’ reputational risks, and their ability to continue being profitable.”
The firm said that engagement was an essential action for long-term investors to encourage companies to adopt best practices that offer long-term risk protection.
While engagement is typically seen as being limited to long-term investors, Aviva noted that short-term investors can roll over investments for multiple years which provides an opportunity for meaningful engagement.
When a company has failed to address a short-term or long-term risk despite engagement, divestment may be the final option for investors.
