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Credit quarterly newsletter: Minimizing risk by doing good

08 October 2019

About Kempen’s Euro Credit team

Kempen’s Euro Credit team runs over EUR 5 billion of assets in a range of strategies, and their outstanding track records illustrate the team’s ability to generate alpha in all kinds of market conditions. Its capabilities have also been recognised by external experts: in March 2019 our Euro Credit team and its flagship fund, Kempen (Lux) Euro Credit Fund, were awarded a Morningstar Gold rating for the quality of their investment process and the strength of the team.

Read more about our Credit strategies

Minimizing risk by doing good

At Kempen we refer to ourselves as long-term engaged shareholders of the firms we invest in, but it’s slightly different for credit investors: by investing in bonds we’re lending money to companies rather than taking a stake in them. This means we don’t get to vote at their Annual General Meetings, but integrating ESG throughout our investment process is still important to us. 

That’s because successful credit investing is all about avoiding the losers, as corporate bonds tend to rise in value slowly but fall quickly if something goes wrong. Incorporating ESG factors is a great way of mitigating risk by avoiding the losers – if you lend money to a company with poor ESG practices it could be subject to serious issues down the line that see its credit profile worsen and the value of its bonds fall. 

What’s more, we’re able to act as a force for good as credit investors. The debt markets are a major source of funding for companies, so by indicating that we will not buy their bonds unless they improve their practices we can persuade companies to improve their ESG credentials.

Years of experience in responsible credit investing
At Kempen we’ve always considered the governance (the G in ESG) of the firms we invest in, looking at aspects such as their ownership structure, possible majority shareholders and subordination. Around six years ago we launched a sustainable credit fund aimed at clients who didn’t want to invest in firms involved in, for example, gambling or alcohol. When we were conducting research for the fund it quickly became apparent that many of the environmental and social issues (the E and S in ESG) we were considering could also be used to reduce the risks that our mainstream credit funds were exposed to, so we started integrating ESG criteria in these strategies too. Having previously only focused on two main pillars for each company – its business and financial profiles – we started at looking at a third: ESG. 

“Incorporating Environmental, Social and Governance (ESG) factors enhances our credit investment process”

Sipke Moes, Senior Portfolio Manager

Integrate, engage and exclude

Today, we incorporate ESG factors in all our credit funds – not just our specialist sustainability strategy – from three angles: integration, engagement and exclusion.

Integration
Integration is the most important aspect of our approach to responsible investing. We perform in-depth analysis of ESG data and risks for each company we are considering, using information from an external data provider (MSCI ESG Research), the corporate sustainability report of the company, public information and input from our responsible investment team. We take a wide variety of ESG matters into consideration, such as water intensity, carbon footprint, health & safety procedures, social practices and labour conditions. Based on our findings, we may decide the following:

  • That the firm’s ESG practices are a not a cause for concern and the company is investable, or even that its good ESG practices are not adequately reflected in its bonds' spreads, making it look a particularly attractive investment opportunity
  • That it is investable, but its ESG practices are worse than similar companies’, so we might require a higher premium if we are to invest in it
  • If we are unsure about some of the ESG information about a company, or if we would like to invest in it but it needs to improve its ESG practices, we may start an engagement with the company
  • If a firm is involved in certain questionable practices, or we don’t like its ESG practices and don’t think there is much chance of an engagement improving them, we avoid investing in it
We also consider controversies that a firm may have been involved in – not just major scandals such as ‘Dieselgate’ at Volkswagen, but also smaller-scale controversies that may not hit the headlines but could be indicative of how a company approaches ESG and hint to further problems in the future. 

Engagement
We engage with companies for two reasons – either to find out more about their ESG practices if we’re unsure whether the information provided by our independent research provider is accurate or, more commonly, to persuade them to improve their ESG practices. As an additional benefit, a successful engagement may lead to other investors becoming willing to invest in the firm, resulting in an improvement in its valuation.

Every quarter our responsible investment team screens our portfolios and highlights any potential ESG laggards or other possible candidates for engagement. If we’re keen on a prospective investment’s business profile and financial profile but have some concerns about ESG that are material, we choose to engage in that case too.

For example, we started an engagement with the utility CEZ because its power mix is primarily based on coal, and we wanted to urge it to adopt a less carbon-intensive energy mix. As well as helping limit carbon emissions, doing so should boost the company’s long-term prospects and, in turn, those of its bonds. It’s quite easy to envisage a situation in the near future where carbon-intensive firms have to pay higher taxes or will face reduced consumer demand, hitting the price of their bonds. But if firms like CEZ reduce their dependency on coal by investing more in renewables, they should be less likely to face problems in the future. Of course, engagements have to be realistic: we cannot expect companies like CEZ to change their energy mix overnight as this would have a big impact on their financial profile. Rather, we hope that their new plants focus on renewables rather than coal.

Another example is our engagement with Volkswagen on its ‘Dieselgate’ scandal. We engaged with the company as it is a major issuer in our universe and has an important role to play in the world’s transition from gasoline-powered cars to electric and hydrogen-powered vehicles. Our engagement focuses on Volkswagen’s plans to change its company culture – one of the main drivers of the scandal, in our view – and its progress in doing so. 

Who’s involved in engagements?

A member of our Credit team leads our engagements, usually with support from one or two members of our specialist responsible investment team. Cases are determined by sector coverage: for example, our healthcare analyst led our engagement with Bayer. We typically undertake 2–5 engagements each year. Within Kempen we try to bundle our forces with people elsewhere in the company – for example, both our Credit team and High Dividend team invest in Royal Dutch Shell, so during the engagement members of both teams as well as our ESG experts were initially involved. In order to increase the impact of our dialogues we also engage in collaboration with other asset managers.

Exclusion

In some cases our engagements are unsuccessful. For example, we engaged with Bayer after its acquisition of Monsanto, which had had a poor reputation for some time. We were keen to find out what Bayer planned to do about this, but unfortunately it would not acknowledge the problems that existed at Monsanto. This led us to avoid investing in the company. Since then Bayer has put out some encouraging statements, but it is not yet enough for us to invest. 
We are convinced our engagements improve results for our clients over the long term. However, there are several instances when we do not engage, choosing instead to directly exclude companies from our investable universe due to the nature of their activities or because of their business conduct. For example, in line with our firm-wide policy we directly exclude companies that are involved in controversial weapons or tobacco. Our sustainable credit fund goes a bit further, also excluding firms involved in areas including alcohol, conventional weapons and gambling.

An effective approach
Over the past few years we’ve successfully integrated ESG factors into our investment process without compromising our investment principles. We continue to manage well-diversified portfolios with a focus on minimising downside. Integrating ESG factors enhances our fundamental assessment of the companies we invest in, and we believe this improves our portfolios’ risk-adjusted return potential. Integrating ESG has also enabled us to encourage positive change at companies through our engagement activities. 

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Disclaimer                                             Risk 4 AFM                                           

Kempen (Lux) Euro High Yield Fund (the “Sub-Fund”) is a sub-fund of Kempen International Funds SICAV (the “Fund”), domiciled in Luxembourg. This Fund is authorised in Luxembourg and is regulated by the Commission de Surveillance du Secteur Financier. Kempen Capital Management N.V. (KCM) is the management company of the Fund. KCM is authorised as management company and regulated by The Netherlands Authority for the Financial Markets.

Paying agent and representative in Switzerland is RBC Investor Services Bank S.A., Bleicherweg 7, CH-8027 Zurich, Switzerland. The Sub-Fund is registered with The Netherlands Authority for the Financial Markets under the license of the Fund.

The information in this document provides insufficient information for an investment decision. Please read the Key Investor Document and the prospectus. These documents as well as annual report, semi-annual report and the articles of incorporation of the Fund are available free of charge at the registered office of the Fund located at 6H, route de Trèves, L-2633 Senningerberg, Luxembourg, at the offices of the representative in Switzerland and on the website of KCM (www.kempen.com/investmentfunds).

The Sub-Fund is registered for offering in a limited number of countries. The countries where the Sub-Fund is registered can be found on the website. The value of your investment may fluctuate. Past performance provides no guarantee for the future. The performance shown does not take account of any commissions and costs charged when subscribing to and redeeming units.

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