Is sustainability at risk of being viewed as a higher-order construct that will fade in relevance as we turn our attention to more pressing issues?
Municipal bonds present sustainable-oriented investors with a unique value proposition. Unlike their corporate or sovereign peers, municipal issuers have long applied bond proceeds to specific, traceable and impactful ends. Municipal bonds finance projects that benefit the public welfare, including those for roads, schools, hospitals and mass transit systems, among other priorities. Even better for sustainable-minded investors, there is a demonstrated correlation in municipal fixed income between the impactful use of bond proceeds and investment performance: bonds that finance essential public needs default less frequently than others.1
However, Breckinridge believes that looking beyond use of proceeds is necessary to establish a fuller picture of an issuer’s sustainable characteristics because these characteristics can impact credit fundamentals. For that reason, Breckinridge analyzes issuers’ environmental, social and governance (ESG) profiles. We believe ESG research helps us price risk that may be overlooked in traditional financial analysis, thereby potentially enhancing risk-adjusted returns while simultaneously providing impact by directing capital to the most sustainable borrowers over the long haul.
In our view, the following is required for strong ESG analysis:
1. A Focus on Material ESG Factors
We believe our integrated ESG approach helps us identify a more comprehensive set of risks than are traditionally considered in municipal analysis. The proliferation of ESG-related data increasingly makes this possible for a large swath of issuers. For example, a general obligation (GO) bond issued by a city or county can now be evaluated on nontraditional factors like crime rate, progress on sustainability planning or economic diversity. Poor performance in one or more of these areas could negatively impact the long-term financial profile of the local government.
Breckinridge’s proprietary municipal research process integrates material ESG factors into each credit review. Factors vary by sector and serve as the building blocks for the sector-specific frameworks we use to evaluate ESG risks. Our nine sector frameworks include those for school districts (see Grading Inclusiveness in Public School Districts), states, cities, counties and hospitals.
2. A Systematic, Transparent Approach
By being systematic in ESG analysis, Breckinridge’s approach is scalable and enables analysts to compare issuers to one another on a variety of metrics. It is also transparent. We seek to share with our clients the metrics and the underlying data/calculations used to assess ESG performance. By following a consistent and transparent process, credit analysts can better express their ESG views on specific issuers, and investment managers can offer better-defined customized portfolios for clients wishing to align to specific values.
3. An Ability to Gather and Analyze ESG Data
The aggregation of ESG data is necessary to perform comprehensive ESG analysis. While data on corporate ESG metrics can be drawn from third parties like MSCI or Sustainalytics, municipal ESG data sets are often disaggregated, overlapping, or incomplete, encompassing a variety of state, federal, and third-party sources.
As such, Breckinridge has created tools to evaluate municipal ESG factors “in house.” Our credit team draws from a wide range of sources, speaks with experts and municipal borrowers, and collaborates with our technology team to gather and curate over 100 metrics to create our municipal ESG frameworks. This approach enables us to innovate and improve our ESG analysis on an ongoing basis.
Breckinridge remains committed to integrating ESG into our bottom-up, fundamental municipal credit research analysis, as we think that ESG research gives us a deeper understanding of borrowers. We also believe that for sustainable strategies to be meaningful, a solid analytical base and a focus on material factors are required. We look forward to continually refining and investing in our ESG processes so that we can produce a better risk-adjusted return for our clients.
 U.S. Municipal Bond Defaults and Recoveries, 1970-2016, as of June 2017. Utility and general government municipals default less (by percentage of the sector) than competitive enterprise municipals.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.
Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.