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What has long been proven in equities is now also the case when it comes to convertible bonds: investing in sustainable companies is beneficial for performance in the long term owing to the increased focus on risk. Hence, sustainable convertible bonds have kept pace well with the wider market over the past ten years – despite a scaled-down investment universe.
As one of the pioneers of investing in sustainable convertible bonds, as of May 2019 Fisch Asset Management can look back over ten years’ experience of managing this strategy. Performance over this period showed that the corresponding product strategy in gross terms performed slightly better overall than the benchmark Thomson Reuters Global Focus Convertible Bond Index, which has produced an annualised return of around 5.4% since May 2009. According to Senior Portfolio Manager Stefan Meyer, “This favourable outcome should be considered in light of the fact that our sustainable investment universe is rather more limited than the overall investment universe due to the strict ESG requirements. There are around 700 liquid convertibles, but only half are actually suitable for investment from a sustainability viewpoint, of which around 70 to 90 make it into the portfolio, ensuring meaningful diversification.”
But performance is only one side of the coin; the other is the risk taken to achieve it. Stefan Meyer firmly believes that ESG will play an even more important role from a risk perspective in the future and will continue to prove itself – because this is where sustainable convertible bonds and their issuers respectively come into their own: On the one hand, a smaller universe tends to result in a more concentrated portfolio with fewer issuers. On the other hand, the sustainable universe contains a higher percentage of high-quality issuers in the investment grade segment. Meyer goes on to explain that, “These blue-chip convertible bonds with a lower probability of default are usually less volatile and typically have a solid bond floor. This means that especially in periods of weakness, the bond component of the convertible should limit potential losses. The combination of both equity and bond characteristics within convertible bonds is the main reason why the asset class has managed to deliver returns close to those of global equity markets over the last 15 years – and this with significantly lower risk measured in terms of volatility.” Global equity market volatility was 13.5% over this extended period versus 9.1% for convertible bonds, while the annualised return was 5.9% versus 5.6% (MSCI World Total Return (EUR hedged) versus Thomson Reuters Global Vanilla Hedged CB Index (EUR hedged), as at 31 May 2019).
As with equities, when investing in convertibles investors should consider the entire market cycle in order to take advantage of these benefits. This is all the more important for sustainable investments – depending on the market environment, there will always be differing short-term developments compared with the traditional universe. Portfolio Manager Stefan Meyer says, “The most unfavourable performance scenario for our ESG portfolio is a phase of sharply rising oil prices. This is because for decarbonisation reasons it avoids oil companies, which typically benefit from higher oil prices. This was the case, for example, in 2016. Conversely, the portfolio gains more during phases of falling oil prices and also Chinese stock market downturns, as the latter often do less well in terms of transparency and corporate governance criteria, and are therefore classified as not sustainable. This scenario played out for much of 2018.” The experience over the past ten years shows that structurally underweighting certain countries or sectors or avoiding them altogether (e.g. defence industry and genetic engineering) in the longer term can be beneficial from a return but particularly also from a risk perspective. Looking at past data, it is clear that the inclusion of ESG factors in portfolio construction led to improved credit quality, making the portfolio more resistant to price corrections.