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ESG investing and money market funds – Odd bedfellows or a good match?

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BNP Paribas Asset Management
 

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Applying ESG[1] considerations to investing is perhaps more obvious when dealing with companies where pollution, health & safety and other issues can be tied to their activities and be tackled more easily. However, in money market investing too, it is valuable to scrutinise ESG standards when addressing, for example, climate change or the energy transition.

Here also, we expect companies to meet their fundamental obligations in the areas of human and labour rights, protecting the environment and ensuring anti-corruption safeguards, wherever they operate, in line with our responsible business conduct policy.[2] This follows UN Global Compact Principles and OECD guidelines for Multinational Enterprises as well as our own guiding principles around investable sectors and those excluded from our portfolios.

Admittedly, implementing ESG rules can curb the range of eligible investment opportunities and affect portfolio yield, but we believe avoiding controversial practices and integrating ESG considerations are key to unlocking long-term sustainable returns.

Responsible business conduct

Under our responsible business conduct policy, we have policies that set out the conditions for investing in particular sectors. For instance, we exclude issuers such as tobacco or coal companies, even if that could limit the returns that can be earned on the portfolio over the short term.

As per our coal policy, for example, we exclude companies generating 10% or more of their revenues from thermal coal.[3] We should note that across the broad money market investment universe comprising almost 3 100 issuers, there are still more than 2 800 that are eligible after this initial selection.

Our RBC policy should be considered as an enhanced risk management tool that can help avoid reputational, regulatory and stranded asset risk. Excluding issuers linked to controversies such as tobacco, controversial weapons or unconventional oil & gas, is sound risk management.

We should point out that issuers in these sectors may have inferior credit ratings affecting portfolio eligibility. Their issuance may also be less liquid, and thus less attractive to us, given investor reluctance to invest in such sectors.

ESG and SRI-labelled money market investing

Before we quantify the effect, we should clarify that our money market funds universe follows two approaches:

  • Money market funds integrating ESG criteria
  • Money market funds using best-in-class selection (‘SRI-labelled funds’).[4]

All our money market funds are classified as Article 8 under SFDR[5], requiring a minimum extra-financial coverage of 90% of the portfolio’s securities or the assets under management. They also target a better ESG score[6] than their investment universe. Best-in-class funds have an additional selection criterion: they exclude the 20% worst performers in terms of their ESG score.

What does that mean for the investment universe? For ESG money market funds, we have identified more than 550 issuers that are covered by in-house credit analysts. Some two-thirds – more than 380 – can be considered ‘high credit quality’ and are eligible for investment by all BNPP AM money market funds.

For SRI-labelled money market funds at BNPP AM, the process involves the exclusion of issuers with a poor ESG score in each sector. That leaves 280 eligible issuers for SRI-labelled funds after excluding the ESG laggards. That is a reduction by about 100 issuers, or around 25% of our internal buy-list. We calculate the opportunity cost of this selectivity as being a negligible one basis point.

On top of this exclusion criterion, SRI-labelled funds aim for a better CO2 footprint6 and greater gender diversity as compared to their investment universe.

Exhibit_1_Money_market_investing_A_two_pronged_approachSource: BNP Paribas Asset Management, as at 28 February 2022

ESG integration

This underscores our belief, as part of our sustainable investment approach, that ESG integration improves risk-adjusted returns, even if – as is the case for money market funds – there could be trade-off between the ESG score and the yield. A high ESG score could mean a lower yield.

However, that stands to reason since a higher score often reflects a lower risk, which means a higher credit rating on average. That in turn allows an issuer to borrow more cheaply in the market.

We have found that even with this inverse relationship, we have been able to earn yields that exceed those of the funds’ benchmarks, supporting the point that ESG integration does not have to come at the expense of performance.

Active ownership

Beyond ESG integration[7] and an exclusion policy, we believe active ownership through stewardship creates value for clients when it comes to money market funds.

This means we engage with issuers and seek to use our influence to advocate for a low-carbon, inclusive economy and encourage them to improve their practices.

Out of the eligible corporate universe for money market funds, we engaged with 80 issuers in 2021.

References

[1] Related to environmental, social and governance issues

[2] Also see Responsible Business Conduct Policy at BNP Paribas Asset Management

[3] Other restriction apply for thermal-coal mining; please refer our RBC policy for details

[4] Socially responsible investing

[5] Also see SFDR – Understanding and implementing it – Investors’ Corner (bnpparibas-am.com)

[6] Also see ESG Scoring Framework at BNP Paribas Asset Management

[7] Also see ESG Integration Guidelines at BNP Paribas Asset Management

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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