Considerable developments have been made in data availability and quality, which means that environmental, social and governance (ESG) factors can now be applied to a range of asset classes. We look at how an ESG aware lens has been applied to the State Street Floating Rate Fund to complement traditional financial analysis and strengthen the quality of the portfolio.
What is the Relevance of ESG in Cash and Liquidity Portfolios?
ESG investing is still in its relative infancy and it is likely to look very different in 5 or 10 years. We believe that the key is to remain flexible with changes in data availability and regulation. The application of ESG factors has historically been focused in equity portfolios, but investors are now considering ESG across a much broader range of asset classes.
We’ve seen considerable development in the cash and liquidity segment, which plays a central role to fully developed portfolios. Cash and liquidity strategies hold a very specific role in portfolios and investors have clearly defined expectations and objectives: capital preservation, liquidity, and yield. We believe that these objectives should take priority when incorporating ESG, which is why we have employed an ESG aware lens in the State Street Floating Rate Fund, because it provides a complementary signal about credit quality.
We believe companies that are managed responsibly deliver better financial results over the long-term which in turn generates more sustainable returns for investors. On the other hand, ESG weakness can be an early warning signal that a company has a greater potential for scandal and has distracted or unfocused management.
So if this is the case, why don’t more cash and liquidity funds adopt an ESG lens?
Why is Data Important When it Comes to ESG?
To measure a company’s ESG performance, we believe that a framework is essential, to measure and score ESG issues that are financially material to specific industries. The biggest challenge for investors has been data, because different data providers and indices employ different definitions. This can lead to a large variance when scoring ESG metrics for the same company. A large part of the variance in scoring can also be attributed to the differences in weightings of various ESG metrics. This can make it difficult to understand the true ESG characteristics of a company.
At State Street, we’ve created a new path to manage these data issues and developed an innovative scoring system called the Responsibility-Factor or R-Factor™. R-Factor™ leverages multiple data sources and aligns them to widely accepted, transparent, financial materiality frameworks to generate a unique ESG score for listed companies that is between 1 and 100.
R-Factor™ was built to solve the data issue and to remove opaqueness around ESG materiality in the scoring process. The score we have developed is powered by multiple ESG data providers which improves coverage and addresses the biases inherent in existing scoring methodologies.
In most markets, R-Factor™ coverage is between 80-90% of the company universe. In the case of Australian denominated Bank Floating Rate issuance, which the State Street Floating Rate Fund invests, the coverage is even higher and 100% of the securities held in the portfolio have an R-Factor™ score.
How is R-Factor™ Being Applied to the State Street Floating Rate Fund?
R-Factor™ has been incorporated in the investment process of the State Street Floating Rate Fund in two ways.
Credit Assessment: It is used as input when company fundamentals are assessed to complement traditional financial analysis; and
Portfolio Construction: R-Factor™ is used as an input, when assessing relative opportunities in conjunction with key inputs such as credit quality, maturity, yield, and price.
Credit Assessment and R-Factor™ Scoring
The State Street Floating Rate Fund is underpinned by research conducted by our specialist Credit Research Team, one of the largest and most experienced in the industry. The team will consider company R-Factor™ scores when assessing credit worthiness.
Companies that meet the credit criteria and have favorable R-Factor™ scores will be added to the Approved Credit List. Company R-Factor™ scores are based on a 0–100 scale where 0 is the “Worst” and 100 is the “Best”. The Fund will exclude exposure to companies that score poorly and are defined as being ESG Laggards or Underperformers.
If an existing credit exposure has an R-Factor™ score that deteriorates, to become a Laggard or Underperformer, the fund will divest from the exposure.
R-Factor™ Scoring Categorisation:
Classification Score (Out of 100)
Portfolio Construction and R-Factor™ Scoring
The approved credit list is the starting point for the portfolio management team to build their portfolios from. The Portfolio Manager will carefully assess the relative value of securities issued from this list and consider what is most appropriate for the Fund to invest in, prioritising the objectives of capital preservation, liquidity, yield, and then the R-Factor™ score. Practically, this means that if there are two exposures with similar attributes, the credit which would be preferred is the one with the higher R-Factor™ score.
This transparent framework ensures that the State Street Floating Rate Fund is able to carefully manage the competing core requirements of yield, liquidity, and capital preservation whilst also providing a level of clarity around ESG exposures that investors are looking for.
Why State Street For ESG
State Street Global Advisors has been managing ESG portfolios for almost four decades. We first incorporated ESG strategies in our equity portfolios in 1985 and into select fixed income portfolios in 1995. We currently manage US$516 Bn in ESG strategies .
At State Street, we use these R-Factor™ scores in our stewardship and engagement program with companies to help define a roadmap to improve ESG performance on the most material issues these companies face. In doing so, we seek to develop more sustainable capital markets and incentivise companies to enhance ESG disclosure.
1 Source: State Street Global Advisors. Estimated and unaudited ESG AUM as of 31 December 2021 for client mandates in the following categories (as defined by United Nations Principles for Responsible Investing): Negative/exclusionary screening: The exclusion from a fund or portfolio of certain sectors, companies or practices based on specific ESG criteria. Norms-based Screening: Screening of investments against minimum standards of business practice based on international norms. Positive/best-in-class screening: Investment in sectors, companies or projects selected for positive ESG performance relative to industry peers. Sustainability themed investing: Investment in themes or assets specifically related to sustainability (for example clean energy, green technology or sustainable agriculture).
Issued by State Street Global Advisors, Australia Services Limited (AFSL Number 274900, ABN 16 108 671 441) ("SSGA, ASL"). Registered office: Level 14, 420 George Street, Sydney, NSW 2000, Australia Telephone: 612 9240-7600 Web: www.ssga.com. State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) ("SSGA Australia") is the Investment Manager.
References to the State Street Floating Rate Fund ("the Fund") in this communication are references to the managed investment scheme domiciled in Australia, promoted by SSGA Australia, in respect of which SSGA ASL is the Responsible Entity. This general information has been prepared without taking into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. You should seek professional advice and consider the product disclosure document, at www.ssga.com, before deciding whether to acquire or continue to hold units in the Fund.
Investing involves risk including the risk of loss of principal.
Floating rate securities are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate securities is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate bank loans can be relatively illiquid and hard to value.
Investors should read and consider the relevant Product Disclosure Statement (PDS) and target market determination (TMD) for a Fund carefully before making an investment decision. A copy of SSGA’s Managed Fund PDS’s and TMD’s are available at www.ssga.com.au.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA Australia’s express written consent.
This material is general information only and does not take into account your individual objectives, financial situation or needs and you should consider whether it is appropriate for you. Investing involves risk including the risk of loss of principal There is no representation or warranty as to the current accuracy of this material, and SSGA Australia shall have no liability for decisions based on such information.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Responsible-Factor (R Factor™) scoring is designed by State Street to reflect certain ESG characteristics and does not represent investment performance. Results generated out of the scoring model is based on sustainability and corporate governance dimensions of a scored entity.
This website is intended for persons resident in Australia. State Street Global Advisors, Australia Services Limited ABN 16 108 671 441, AFSL Number 274900 ("SSGA, ASL") is the product issuer. State Street Global Advisors, Australia, Limited (AFSL Number 238276, ABN 42 003 914 225) (“SSGA Australia”) is the Investment Manager. The material on this website is general information only and does not take into account your individual objectives, financial situation or needs.
You should seek professional advice and consider the Product Disclosure Statement (PDS) and target market determination, available at www.ssga.com, before deciding whether to acquire or continue to hold units in the Funds.
You can access our PDS online or by calling us. The offer made in our PDS is available to persons receiving the PDS within Australia and applications from outside Australia will not be accepted. Past performance is not a reliable indicator of future performance. Investing entails risks and there can be no assurance that State Street Global Advisors will achieve profits or avoid incurring losses.
Investing involves risk including the risk of loss of principal. This material should not be considered a solicitation to apply for interests in the Funds and investors should obtain independent financial and other professional advice before making investment decisions. There is no representation or warranty as to the currency or accuracy of, nor liability for, decisions based on such information. Performance quoted represents past performance, which is not a reliable indicator of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted.