Eyes on corporate governance, especially in a time of volatility
Three out of five Astute Investors have already integrated ESG factors into their credit analysis
31 Oct 2019 | Aaron Leung
Bracing for a possible recession in the coming 12 months, risk mitigation will be a common theme for Asian fixed income investors in the coming year, a recent survey of 255 Astute Investors has shown. In the survey, conducted by Asset Benchmark Research, 60% of respondents expect governance to be of increasing importance as credit selectivity becomes even more paramount.
“Governance has always been an important rating driver and ESG risk factor for Asian issuers for an extended period of time, yet it appears to become more important,” says Jin Hur at First State Investments, in Hong Kong. “We have witnessed a few idiosyncratic credit events involving issues relating to corporate governance, and a wider group of investors now appear to be gauging governance related risks in their credit selection process.”
In the same study, two-thirds of Astute Investors reported that ESG data has already been integrated into their fundamental credit analysis. This reflects the industry consensus that ESG, especially corporate governance, has a material impact on creditworthiness. “Regulatory compliance, client awareness, and long-term performance are all correlated with higher ESG scoring companies, especially from the corporate governance angle, which impacts credit,” comments Eric Liu, head of fixed income at Harvest Global Investments.
While ESG principles have become more accepted as an industry norm, there are still shortcomings. Only a third (35%) of Astute Investors are already integrating ESG factors into the portfolio construction process, suggesting that a minority of investors would adjust their weightings of securities after taking the company’s ESG performance into consideration.
Words are not always matched by deeds. Only a quarter (26%) of investors would regularly adjust their valuation models to ESG into consideration, while 28% of them would rarely or even never do so.
A chief investment officer, who always makes portfolio adjustments to reflect ESG evaluations, warns: “Asia is full of corporate governance disasters. Too often companies have the ability to repay but quite often not the willingness. It becomes clouded by succession plans and poor transparency.”
The lack of transparency also hinders the progress of ESG factor integration in credit risk analysis. More than half (58%) of the Astute Investors suggest that limitations in the visibility of ESG risks and the availability of comparative data are the top two difficulties they have to overcome when integrating ESG factors.
Abhishek Rawat, portfolio manager at Hong Kong Asset Management, believes that the frequent blow-ups in the Asian credit space are attributed to weak corporate governance of issuers. “If fund managers can navigate this issue by careful credit selection, they would outperform. Conversely, if regulatory frameworks can enforce better governance, the average credit spreads as well as volatility could be lower and the whole bond market will benefit.”
The rapid expanding nature of Asian bond market also adds extra importance to corporate governance. “Fast-growing demand for Asian credit in the past two to three years has led to covenant-light bond issuance, and that results in many idiosyncratic risks, in particular to those China and Indonesia high-yield issuers,” observes Mark Lo, head of fixed income, AMTD Group.
Requirements from investment mandates, especially ex-Asia, are pushing further ESG integration in the investment process. According to the ABR study, half (51%) of the Astute Investors rank client demand and fiduciary duty as the top drivers for ESG integration in credit analysis.
“Since all my investors are institutions outside of greater China with many from the Scandinavian and Nordic area, their awareness of ESG is quite high and they demand that managers include an ESG framework in the investment process,” explains Edmund Ng at Eastfort Asset Management.
Though regulatory requirements ranked after client demand and fiduciary duty in terms of importance, as the market matures, regulators will continue to urge Asian corporates to achieve higher ESG standards. Consequently, investment in Asia will be forced to comply with higher ESG standards to a point where all available assets are ESG-compliant.
Financial institutions will also help raise ESG standards in the region. Javier Segovia, head of EM corporate research at TCW in the US, comments, “As more issuers come to the market and bank financing becomes more restrictive, corporate governance risk will be more important.”
Irrespective of the external environment, corporate governance will continue to play a big role in attracting long-term investors.
Mark Kennedy, CIO at Wake Asset Management, crystallizes the argument, “Corporate governance deals with a company’s management, C-suite salaries and bonuses, audits, internal controls, and shareholder rights, amongst other many things. Investors need to know that an issuer uses reliable and fully transparent accounting standards and practices. The integrity of management is an indispensable starting point to enable trust between stakeholders and the company. The alignment of management and stakeholders is critical to secure the trust necessary to work, invest and make decisions together. Hence it precedes any other issue. Without that, there is no point looking into anything else the company does, whether in ESG or in any other subject.” 
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