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Q&A: A New, ESG View of Bond Risks

Fixed-income portfolio manager Steve Liberatore says ESG risks are tied to the long-term viability of issuers.

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Editor’s note: This is one in a series of Q&As with financial professionals about how they’re incorporating environmental, social, and governance factors into their investing approaches and their views on ESG risk.

Steve Liberatore is the manager of Bronze-rated TIAA-CREF Social Choice Bond (TSBRX), which applies ESG screens on potential holdings and invests in project-specific bonds that fund ESG initiatives such as affordable housing, community development, and wind farms.

Has considering ESG issues made you a better investor?
I believe ESG has definitely made me a better investor. Taking environmental, social, and governance factors into consideration has helped me to focus on second and third derivative risks, which tie directly to the long-run strategic viability of issuers. 

Volkswagen (VLKAF) was downgraded after the emissions scandal; Wells Fargo (WFC) was downgraded after the fake accounts came out. How could an ESG analysis have helped investors avoid these downgrades?
An ESG analysis would have highlighted the historical governance issues within both companies, neither of which had materially corrected these weaknesses over the years.

Do you have any examples of trouble you dodged due to your ESG analysis?
In addition to the above issuers, Ford (F) was another company we did not invest in over ESG concerns, which allowed us to avoid its downgrade to below investment grade and widening of credit spreads. Our ESG-related concerns revolved around the frequency of its product recalls and associated impact on free cash flow generation as well as its ownership structure/concentration relative to its peer group. 

How far has the bond market come in properly incorporating ESG risks into its analysis of companies?
I believe that the process of truly integrating ESG analysis into the fixed-income markets is still nascent. However, I expect that this will increase and improve rapidly in the next few years in response to investor demand and recognition of benefits to the investment process, including risk mitigation.

Which ESG risks concern you the most as a bond investor?
As a predominantly unsecured lender, governance is the ESG factor that concerns me the most. You do not want to be invested in an issuer whose financial data can’t be trusted. 

This article originally appeared in the first-quarter 2020 issue of Morningstar magazine. Learn how financial professionals can subscribe for free.

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