ESG bond funds – YTD review
The spread of COVID-19 across the planet led to the shutdown of the entire economy during a major part of the spring. The slumps in economic activity during the 2nd quarter were quite simply historic. The return to a normalized situation seems uncertain, in particular in many cyclical sectors, such as leisure or the aviation industry.
Market context
COVID-19 Crisis
The spread of COVID-19 across the planet led to the shutdown of the entire economy during a major part of the spring. The slumps in economic activity during the 2nd quarter were quite simply historic. The return to a normalized situation seems uncertain, in particular in many cyclical sectors, such as leisure or the aviation industry.
Reduced prices for the risky asset classes
During the crisis, capital flow was massively diverted away from the risky asset classes. We therefore witnessed falling prices for corporate debt, together with an increase in lending rates. In the sovereign debt universe, peripheral countries’ spread widened, while the debts of the core countries of the euro zone, as well as US Treasuries, held firm, performing their function as shock absorbers during the risk-averse phases of the crisis.
In response to the powerful support provided by central banks, aimed at ensuring the liquidity of the financial markets, and to the steps taken by governments to calm the economic and cash-flow anxieties of the private sector, the stock markets have now revived. For example, the credit spreads have been significantly normalized, even though they remain at higher levels than before the crisis.
Rapid restoration of technical support
Overall, year-to-date, capital flows have been positive in the credit asset class, despite the outflows observed during the months of February / March. The appetite for this asset class has recovered rapidly following the announcements of the central banks, which are massively purchasing both sovereign and corporate debts at historically high levels. Technical support for sovereign debt is therefore also strong.
In particular, the enthusiasm for green bonds has not diminished, despite the crisis. This is confirmed by the new primary issues, which were largely oversubscribed both before and after the financial storm caused by the COVID-19 crisis. According to Moody’s, the total sum of new green issues is expected to exceed 200 billion dollars, compared to 9 billion in 2014.
So, as we emerge from the crisis, the trends observed for these funds since 2019, such as the acceleration of the energy transition have been maintained and even reinforced. By way of example, we can cite TenneT, the Dutch electricity transmission system operator (TSO), which brought the long line of new hybrid issues to a close before the 2020 summer break, with a green bond of one billion euros (with overall investor interest of about 2.5 billion euros). This bond aims to develop renewable energies, especially wind turbines, in the Netherlands and Germany.
More recently, in early September, Germany finally issued a green bond with 10-year maturity, the first in a long series, to finance investment in the ecological and energy transition. Germany had initially planned to issue a 4 billion euro bond in the first phase, but ultimately increased the issue to 6 billion in the face of massive investor interest (more than 30 billion euros).
G Fund Credit Euro ISR
Recap of our investment philosophy
G Fund Credit Euro ISR(1) is a fund that focuses on long-term performance by investing mainly in corporate debt securities issued by companies considered to be the most virtuous in terms of ESG. The fund aims to outperform our benchmark index, the Barclays Capital Euro Aggregate Corporate Clôture, by operating 4 main performance drivers, starting with issuer selection, and supplemented by directional exposure, sectoral allocation, and country allocation.
The choice of securities is essentially made from Investment Grade2 corporate bonds denominated in euros..
Our ESG philosophy(3)
G Fund Crédit Euro ISR adopts an “SRI Core” approach based on a best-in-class methodology, i.e. it prioritizes issuers judged to be the most socially responsible in their sector in terms of ESG, with overexposure to quintiles 1 and 2 and underexposure to quintile 4 compared to their benchmark index, while we totally exclude the least socially responsible issuers (quintile 5, or 20% of the index).
Our approach is based on both quantitative analysis, for the definition of the eligible universe, and the qualitative analysis provided by our extra-financial analysts.
The fund undertakes to offer a structurally better ESG rating than its reference index. The fund has recurrently obtained the French government’s SRI reference label, as a guarantee of the quality of our commitment to socially responsible investment.
Notes on performance
Sources: Groupama Asset Management. G Fund Credit Euro ISR M-C – EUR: FR0010702159. Groupama Credit Euro M-C – EUR: FR0010758847. Indexes expressed in euros. The Barclays Euro Corporates Index EUR is the reference index for both funds. Data as on 31 August 2020. YTD: Year-to-date Past performance is not a reliable indicator of future performance.
The main risks associated with the two funds are interest rate risk, credit risk, liquidity risk, capital loss risk and derivative instrument risk.
G Fund Credit Euro ISR has traditionally had a lower sensitivity to the credit market than its equivalent non-SRI fund managed by our company (Groupama Credit Euro). This is because our non-ISR fund is more “aggressive” in its positioning, both on financial subordinated debts and on hybrids, which are more sensitive to market upheavals.
The more “defensive” positioning of G Fund Credit Euro ISR is combined with our selection of issuers considered to be of higher quality in the portfolio. This is essentially due to our SRI filter, which attributes a more defensive bias on the companies of the industrial sector, which are usually more cyclical. These elements of differentiation have provided the roots for the outperformance of G Fund Credit Euro ISR compared to its non-SRI equivalent since the beginning of 2020.
The performance of G Fund Credit Euro ISR is globally below its benchmark index, being penalized by the health crisis and the fragmentation of the markets. For example, at the beginning of the crisis, in the aim of implementing a carry strategy, the fund took on higher market risk through its overexposure to subordinated debt (in particular financial subordinated debt) and High Yield debt(2).
With regard to the factors having a positive effect on relative performance, the over-sensitivity to interest rate risk performed its function well in a market where interest rates were on a downward spiral. The fund benefitted from credit hedges that the fund managers established via the derivatives markets in response to the first signs of the epidemic in China. Sector allocation (over-exposure to non-cyclical sectors versus cyclical sectors) also mitigated the underperformance of the funds.
The green figure
As at the end of July, the carbon footprint of the fund is:
Versus 519 tCO2 for its benchmark index. The carbon footprint corresponds to average emissions of greenhouse gases per million euros of revenue. Sources: Beyond Ratings, calculations by Groupama AM.
Prospects and positioning
We remain constructive on the credit asset class, where spreads have not yet pulled back the full widening registered over 2020. The considerable support of the central banks, the appetite of investors for this segment and, finally, an end-of-year primary market offer that is expected to be less strong than in previous years all argue for a continued narrowing of spreads.
By contrast, we are under-exposed to the cyclical sectors most sensitive to an economic downturn, namely the automotive sector and metals / mines. However, during the summer, we restored our exposure to the cyclical sectors that appear capable of absorbing the impact of the crisis (energy and basic industries). We are also investing in the sectors least exposed to a contraction in activity, such as the Utilities, Telecommunications and Non-cyclical Consumer sectors.
We are maintaining our preference for financial securities, with a bias to the subordinated debts of leading national entities. All the measures announced by the European Central Bank are designed to provide long-term support to the banking sector, which has declined in value.
We have largely reduced our exposure to High Yield securities by reselling the most volatile securities. We have only kept the High Yield debt securities from issuers that have retained their Investment Grade rating. In the Investment Grade universe, we have also reduced specific risk, as in the case of Schaeffler, Ford Motors and Rolls Royce, which are flirting with the High Yield zone.
In terms of countries, we are maintaining an over-exposure to the corporate debts of the peripheral countries (Spain, in particular, and, to a lesser extent, Italy).
On the credit yield curve, we are prioritizing the intermediate 3-7 year segment and are under-exposed to the long segments (15 years and over), which are more exposed to a shift towards higher interest rates.
G Fund Global Green Bonds
Recap of our investment philosophy
G Fund Global Green Bonds invests mainly in “green bonds” denominated in euros issued by the countries of the OECD. This fund aims to help to sustain the momentum of issuers in their ecological and energy transition activities, while also seeking to outperform the benchmark index, Barclays MSCI Global Green Bond hedged en euros.
The investment process combines the directional, relative value and insurance approaches.
Our ESG philosophy
This “impact fund” is designed to finance projects having a positive impact on the environment. It invests in a set of selected projects that contribute to the ecological transition, in particular in the domains of renewable energy, clean transport, waste management and water conservation.
The eligibility universe of green bonds defined by Groupama Asset Management is based on the characteristics of the issue and issuer, the environmental quality of the projects and the transparency of their reporting. Our internal methodology can induce us to refuse the admission of certain green bonds into our universe if the criteria are not – or are no longer – satisfied by the issuer. For example, this year, recently, we have sold off our position on the green bond of Italian company Hera due to the lack of transparency regarding the sound allocation of the funds raised.
Notes on performance
Sources: Groupama Asset Management. G Fund Global Green Bonds I-C – EUR: FR0010213397. G Fund Global Bonds I-C – EUR: LU1501414277. Indexes expressed in euros. The Barclays MSCI Global Green Bonds EUR is the benchmark index of G Fund Global Bonds. Data as on 31 August 2020. Past performance is not a reliable indicator of future performance.
The main risks associated with the fund are capital loss risk, interest rate risk, credit risk, counterparty risk and derivative instrument risk.
For the year-to-date, green bonds are among the best fixed-income asset classes in terms of performance, since they have benefitted from the effects of the reduced interest rates and their resilient character.
Our fund also contains bonds issued by private companies, Agencies, Supranational entities and for some of them, we are overweight. In the context of the extreme risk aversion that we experienced during February-March, these bonds suffered. For example, we can cite financial bonds (Unibail), insurance bonds (Swiss Re) or the bond of the supranational Asian Development Bank.
Another notable point of difference with the reference index is that the US are under-represented. Our methodology rules out many American green bonds included in the reference index. So, our Green fund is less exposed to the United States and is therefore automatically more concentrated on the European zone. At the same time, the room for manoeuvre of the American Federal Reserve has permitted drastic reductions in the interest rates of American Treasuriess (which have therefore automatically appreciated in price), which has adversely affected in relative terms.
The green figure
As at the end of August 2020, the investment of the fund corresponding to the Sustainable Development Goals (SDG) defined by the UN is allocated as follows:
Contribution to the SDG in % of NAV (excluding liquidities). Source: Groupama AM. In addition, the carbon footprint of the fund is 1,108 tons of CO2 compared to 1,307 for its benchmark index at the end of August 2020 (sources: Beyond Ratings, Groupama AM calculations).
Prospects and positioning
We remain confident in the green bonds asset class. The overall trend remains promising, with increasing numbers of issuers willing to undertake projects in support of the energy transition. On the investor side, the appetite for this type of bonds has not waned, as can be seen from the success of the issues on the primary market, which are largely oversubscribed.
Moreover, green bonds seem to be held by “long-term” investors who keep their securities for longer than average. This characteristic results in less volatility during the phases of market stress.
In terms of positioning, we have retained our pocket of corporate bonds from issuers judged to have very reliable credit profiles, especially in the Utilities sector. We are maintaining an over-sensitivity to European bonds (by design and ECB support), in particular British bonds. British bonds are expected to continue to benefit from the highly accommodative environment established by the Bank of England, which is deploying every effort to prevent stalling of the economy, despite the health crisis and the exit from the single European market.
Groupama Etat Euro ISR
Recap of our investment philosophy
Groupama Etat Euro ISR is a fixed income fund investing mainly in sovereign debt denominated in euros. A diversification pocket is also traditionally constituted via bonds issued by Agencies, Supranational entities and Local Authorities. We aim to outperform the reference index, the Barclays Euro Aggregate Treasury Clôture.
Our ESG philosophy
The ESG approach of the Groupama Etat Euro ISR fund is based on the conviction that, in the long term, a state that benefits from higher ratings in the SRI criteria will register longer-lasting and less volatile growth.
Country ratings are based on 35 sustainable development indicators designed to take into account institutional, governance, environmental, social and societal factors (ESSG pillars). Our proprietary rating methodology aims to provide a snapshot of a country’s performance in terms of its sustainable development policy.
More precisely, our method classifies and rates the capability of countries to establish sustainable growth over the long term. The implementation of SRI in the process increases or reduces the exposure of each country relative to the benchmark, according to the country’s SRI rating.
The fund undertakes to offer a structurally better ESG rating than that of its benchmark index, and the fund management aims to maintain a share of at least 30% of green bonds in the portfolio for diversification purposes provided that the bonds are validated as “green” by our internal analysts.
Notes on performance
Sources: Groupama Asset Management. Groupama Etat Euro ISR I-D – EUR: FR0010973149. Groupama Etat Euro I-C – EUR FR0010174631. Indexes expressed in euros. Le Barclays Euro Treasury EUR is the benchmark index for both funds. Data as on 31 August 2020. Past performance is not a reliable indicator of future performance.
The main risks associated with the fund are capital loss risk, interest rate risk, credit risk, counterparty risk and derivative instrument risk.
In the turbulent environment of this year, Groupama Etat Euro ISR has benefitted from the instinct of investors to fall back on more reliable assets, such as sovereign debts, and from the stimulus provided by the central banks, with their massive purchases of sovereign debts. However, peripheral debts, which are considered riskier, have brought volatility to the fund during the period of financial crisis.
Groupama Etat Euro ISR has a diversification pocket with green bonds that are issued, for example, by parastatal companies (SNCF Réseau), Agencies (KFW) or supranational entities (European Investment Bank), which were harder hit than state bonds during the crisis, in particular in the short-term segments of the curve.
During the last few months, we have benefitted only marginally from the good performance of the sovereign debt of the peripheral countries, such as Italy and Spain, for which we generally attribute lower ESG ratings than countries of Northern countries. Therefore, the overexposure to debt that we have established in our non-ESG strategies was only minimally applied in Groupama Etat Euro ISR, in order to maintain a high ESG rating for the portfolio.
The green figure
Source: Eurostat, World Bank, Groupama AM. Data as at end of August 2020
Our decision to increase our share of green bonds in the fund has boosted the ESG rating of Groupama Etat Euro ISR. In this context, we have recently invested in the Danish parastatal company Orsted, which specialized in renewable energies, and in SNCF Réseau: both of these companies have very high ESG ratings. However, not all green bonds are more highly rated than their sovereign equivalent: for example, we turned down the bond of the Community of Madrid, which was less highly rated than the Spanish state.
To preserve a rating substantially higher than our benchmark, we accord long-term preference to Sweden, Finland and Luxembourg.
Prospects and positioning
In a historically accommodating monetary context, we are adopting a strategy of over-sensitivity to interest rates in the euro zone. In line with our SRI filter, this exposure is initially implemented in the core and semi-core countries.
Moreover, our SRI filter generally attributes lower ratings to the peripheral countries. After the strong rallying of debts during the summer, we are more comfortable returning to a neutral position relative to our benchmark index.
(1) ISR is the French acronym for SRI, Socially Responsible Investment
(2) Investment Grade: high credit quality according to the Rating Agencies (minimum rating BBB-). High Yield: credit rating strictly below BBB- by the Credit Rating Agencies.
(3) ESG: this acronym designates the Environmental, Social and Governance (ESG) criteria used for conducting extra-financial analysis of a company.
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