Bringing ESG Materiality to Fixed Income - State Street Floating Rate Fund

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.

  1. Credit Assessment:  It is used as input when company fundamentals are assessed to complement traditional financial analysis; and 
  2. 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)
Laggard 0-10
Underperformer 10-30
Average  30-70
Outperformer 70-90
Leader 90-100

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.

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