Exploring ESG in Municipal Markets
Hi. I’m Annika Lombardi, Portfolio Manager of Lord Abbett’s Climate Focused Bond Fund. To help tell the story of Environmental, Social and Governance -- or ESG – investing at Lord Abbett, I’ll be sharing some of the conversations I’m having with other investment leaders throughout the firm. We talk about their career paths, what ESG means to them, and how we collaborate to develop sustainable, ESG strategies. I hope you enjoy it as much as I do.
You’re listening to Green Shoots.
My first conversation was with Eric Friedland, Director of Research for Municipal Bonds here at Lord Abbett. While municipal bonds are a U.S.-specific asset class, the collaboration across teams within the firm to analyze ESG strategies transcends borders. There’s also a natural correlation between the environmental and governance aspects of ESG and municipal bond investing. Think: Clean water for cities and green spaces in city planning. Let’s start by getting to know Eric with a little history on how he chose his career path. Here’s Eric
It’s interesting. One of the reasons I got involved with [public] finance was that I was always interested in finance. I also was interested in not-for-profits and governments. And I found municipal finance was a good way to blend the two.
And by being involved in public finance, there was this public purpose component, which in many ways is, you know, is similar to what ESG is.
I should note here that when Eric and I talk about “ESG” we mean
Now back to my conversation with Eric
So as a research director, why do you believe ESG is important?
… There’s a great quote that I once heard, that, you know, it always sticks with me. It’s “ESG is not about change the world. It’s about understanding how the world is changing”.
…I think it’s very important. And – in many…. It’s really an extension of a process that we’ve already been employing. One of the things I really take pride in in our group is that we do in-depth fundamental analysis. And this is really taking it to – the next level, considering factors that may be more contemporary, more evolved, and focusing on those factors that we may not have been recognizing as being so critical as before.
Investors have increasingly sought portfolios that better reflect their personal values like climate changes, equality, accountability. So ESG really better aligns investor goals and concerns with risk assessment and security selection.
So we hear a lot about ESG in equities and more and more so in traditional taxable fixed income. But historically there hasn’t been much focus on ESG investing in municipal bonds. Now, I know you personally believe that municipal bonds are actually a perfect fit for ESG investing. Can you elaborate on that a little bit?
…When you think about what the proceeds of municipal bonds are being used for, or when you think about what the mission of municipal issuers is, it's a perfect fit. You think about water utilities. You think about electric power. You think about renewable energy. You think about toll roads, which are actually, a lot of times, you know, systems created to alleviate congestion. So you know, name a sector in municipal bond asset class, and there's an issuer that's providing some type of ESG- related impact.
So based on what you just said, do you think ESG factors are actually being reflected in municipal bond valuations right now?
They’re not. We’re not seeing any meaningful price differences between those that are deemed to be green or not green. But that’s not to say it’s not going to change going forward. I think that as more and more analysts, portfolio managers, investors begin to recognize that ESG factors can have a critical impact on credit, then that will become priced in.
For our listeners: When Eric says “green” or “not green”, he means (ANNIKA to elaborate)
Now for the practical application:
…Could you give us a little more color on what ESG integration actually looks like on a day to day basis for your analysts and portfolio managers?
…We don't have a third-party data provider. So our analysts have to come up with-- you know, a set of metrics that they believe is most meaningful to the sectors that they follow. So what we did at the start was we got together and thought about a list of metrics, again, each that would be important for a particular sector or sectors.
In the end, we came up with a list of 83 metrics for the 10 different sectors that we cover.
…It’s important for us to have this materiality map. Because it gives us a way to sort of come back and-- have some alignment and-- consistently think about what it is that we should be considering when evaluating an issuer and putting an ESG score on an issuer.
Could you maybe give us a couple examples of those metrics? So say, for instance, for a hospital, what is one metric you would consider? Or for a water utility, what's one metric you would consider?
For a hospital and a CCRC, there's something called a star system, which is a measure of patient quality. And that's something that we really hadn't been considering in our day to day analysis before. But there are now sources of that information.
ANNIKAI should note here that the “CCRC” segment Eric refers to stands for Continuing Care Retirement Communities, which provide long-term care for older individuals.
So our analysts are starting to look at that. And again, higher quality would indicate, you know, better ESG behavior. So that's one thing we look at there. You know, when we look at water utilities-- water leakage is something that we pay attention to. So there are some-- providers that-- will report water leakage or issues that water treatment as well.
This is just one area of Eric’s work that I find especially interesting, and really pretty impressive: The Municipal Bond research analyst team has come up with this list of metrics on its own. So we dug a little deeper into how this works.
…Are there any examples of issuers that you've either decided to purchase or not purchase based on their ESG profile?
Yeah, so there are many examples that I can give you. I think some of the most interesting are some of the positive ESG factors that we've identified. Because everyone sort of always sort of focuses on the negative ones. So one of the examples, there's a water agency in California. And what's interesting about them is that they have several water treatment plants that are powered by solar energy.
Another one that we ended up buying is there was a water and sewer system in Texas. And one of the issues in Texas is that there's a decline in aquifer levels.
There's been big droughts there. So to us, one of the things that is most impressive was they have a very strong groundwater protection management and leakage mitigation program.
And then finally, there's a children's hospital in southern Florida. And as we all know there's severe wind conditions in southern Florida with hurricanes and tornadoes. So one of the things that, again I as I mentioned, we don't just not buy something because of one particular issue.
We don't exclude issuers. Our analysts do deep in-depth research. So the fact that the hospital is located in south Florida in a hurricane zone didn't mean that we were going to exclude it from our portfolios. What our analysts did was they did further research and learned that this hospital had taken some pretty significant mitigation plans. They had put up wind-resistant framing and wind-resistant windows. So we knew that they were being proactive and they would be in a good position to survive a severe storm.
Eric and I also talked about issuers that the team decided not to invest in because of ESG risks, including a sewer system in Arkansas, which had a leakage problem. This environmental risk – and local governance issue – was something the team decided to avoid. It’s an exhaustive process.
…It seems like while your team does incorporate a lot of ESG factors into the investment process, we're still in fairly early stages in the overall asset class in terms of investor focus, as well as data availability. How do you think ESG investing in the municipal bond market will evolve over the next couple years?
I do believe that given the intense focus on ESG and the demand that investors are gonna have on asset managers having ESG-themed products, that there will be more third party ESG data providers for munis. So I see that day coming very soon.
I also think that, like us, many of our peers will take a more authentic approach where they'll use a more holistic type of analysis. And, given all of that, as I mentioned before, where I don't think that ESG is priced into municipal bond investments right now, I do see a time when it will be.
… Thanks so much for your time today. I really enjoyed hearing about your perspective of ESG and municipal bonds. And hopefully speak to you again soon.
…Thank you, Annika. It was a pleasure to be here speaking to you about ESG today.
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