Private credit markets – optimism grows, but caution is warranted

Activity levels in many private credit markets have unsurprisingly picked up over recent quarters as public markets bounced back, adding to the robust and growing pipeline of opportunities we are seeing across the breadth of the asset universe.

Discover more in M&G Investment’s latest spotlight on private credit markets, where they also take a closer look at the topic of environmental, social and governance and what it means in private credit investing.

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Scott Kalb and CalSTRS’ Aeisha Mastagni discuss what is next for investor action in sustainability. They reflect on the dangers of funding sedition following the 6th January riots. Investors rarely consider the risk of investee companies financing extreme groups, but it threatens the very system on which institutional investment relies.

Asset owners face the uncomfortable prospect that the companies in which they invest could be funding extremist groups, some engaged in sedition. Speaking at “Sustainability Digital: A Planet in Trouble,” Scott Kalb, director of the Responsible Asset Allocator Initiative (RAAI) at think tank New America, told delegates that they might have unknowingly invested in companies funding the siege of the capital. ESG doesn’t address political spending risk, he said.

Kalb said it was a risk that asset owners need to take seriously. He said screening out political risk required better asset owner education and investors using their proxy voting power to improve corporate disclosure on political spending.

“Asset owners should adopt policies on political spending as part of an ESG framework and put their asset managers on watch to the risk, notifying them that they won’t tolerate investment in companies spreading disinformation or engaged in violent activity.”

Moreover, he said these groups threaten the very system on which institutional investors rely like the rule of law.

“If you are a good steward of capital, investing in companies that have poor transparency regarding political funding contravenes good governance.”

He said that political spending poses a systemic risk to capitalism if companies can influence an election result “to get the rules in their favour.” Adding that it is incumbent on investors to protect capitalism and the institutions that underpin it and to think about “how portfolio companies are impacting the world and externalizing costs onto stakeholders.”

 

Fellow panellist Aeisha Mastagni, portfolio manager at US pension fund CalSTRS agreed that funding sedition was something investors should be looking at, adding that the events of January 6th had cast political spending and contributions into the spotlight, and necessitated strong corporate board oversight.

CalSTRS directs its active stewardship to four key areas that it believes are relevant to the long-term performance of its portfolio – targeting policy makers to promote sustainable markets, corporate board effectiveness, the low carbon transition and responsible firearms.

Tools include proxy voting and engagement in a strategy that Mastagni described as a “continuum,” with CalSTRS increasingly deploying more resources to influence change.

“We pair our role as an engaged, constructive shareholder with deep financial analysis and a path to value creation,” she said.

For example, CalSTRS will support an alternate slate of board members at ExxonMobil being put forth by active ownership organization Engine No. 1, explained Mastagni.

Activists want the oil giant to ramp up investments to clean energy and adapt to the rapidly changing energy landscape.

Although CalSTRS is not part of this solicitation, she said the pension fund plans to vote and support the alternative slate.

“Now is the time to change, and we need significant change in this boardroom,” she said.

Reflecting on the work of the RAAI Kalb explained that the initiative identifies the top 25 institutional investors leading responsible investment. Asset owners are rated based on 10 principles and 30 criteria like integration, transparency and disclosure.

“We are looking for evidence of real action, trying to create a standard of excellence people can aspire to,” he said. He explained to delegates that most of the cohort is focused on climate change.

“There is an understanding that as long-term investors they have an obligation to savers and stakeholders to not invest in companies that might harm their interests,” he concluded.

Gloria Steinem tells institutional investors it is time to ditch the labels that describe our gender, class or ethnicity and urged the investment community to look at investments through the lens of gender, class and racial equality.

“We need to become individuals without adjectives that describe our gender or class,” says celebrated feminist and social political activist Gloria Steinem.

Speaking at “Sustainability Digital: A Planet in Trouble,” 86-year-old Steinem stressed the importance of understanding that each human being is unique.

“Humanity is the point,” she said, urging delegates to see the individual behind the label – to look at our substance and content.

The ‘unfinished business’ and ‘human rights challenge’ of gender equality is rooted in long held racial and gender divisions viewed as desirable.

“It’s taken us a long time to realise that money is just one form of value,” said Steinem who said the tide began to shift with social justice movements that saw the quality of life not just measured on a financial scale.

She noted a new energy to gender equality under the Biden administration. She also drew delegates attention to the sweeping transition underway in the US population from “majority white” to “majority people of colour.”

She said that among a percentage of the population, this transition was sparking insecurity and rebellion, witnessed on the 6th of January storming of the Capitol by a white minority.

“Trump wasn’t elected by a majority but by a fluke of the electoral college,” she said.

Steinem played down polarisation in the US, arguing that resistance to multiculturalism only comes from a minority. She said that Trump represented that minority (white and male) that is resisting the fact the US is about to become a non-white country – alongside other changes.

“We are now back to majority democratic rule,” she said.

As to how diversity sits within the broader sustainability debate, she said it comes down to “the common sense” principle of the importance of releasing all talents, not just the talents of some people.

She said inequality has its roots in colonialism, hierarchy and European religions and values. Besides, the original inhabitants in the US lived by a circular model “before Europeans came along.” Adding: “In a sense we are trying to get back to this.”

It led her to reflect on the fact women are less hierarchical in leadership roles stemming from models of behaviour and leadership rooted in the family. It reflects a “concern for the welfare” of each person regardless of where they are in a family, in contrast to the corporate model. She also noted more men working from home as being one of the positives to come out of the pandemic.

“Men are more likely to be at home and take care of children and be present in the household,” she said. “It is equalizing what until now has been a female experience.”

She urged the investment community to look at investments through the lens of gender, class and racial equality.

“There is not simply just one measurable number,” she said.

Dropping labels allows “instant communication” amongst strangers. She also espoused the importance of laughter. Although social movements are often viewed as serious and full of anger, laughter is powerful source of free emotion.

“You can compel fear or love; laughter can’t be compelled.”

She said this was the “undervalued” element of a social justice movement and embodied freedom and enjoyment.

“You can’t live in the past or future, you can only live in the moment and the ability to laugh is proof of that.”

She concluded that retirement is another label to ditch. She said as long as individuals can “still function,” and their advice is useful, we should dispense with retirement. Moreover, young people should be encouraged to work much earlier.

“There are teenage geniuses that are functional; the idea of functionality should surpass ideas of age, race and class,” she said.

The impact of climate change is already material, said Woodwell Climate Research Center’s Philip Duffy who warns that thawing permafrost could mean the loss of control of ever being able to manage climate change. Elsewhere, he urged investors to use their voice to bring about change.

The impact of climate change is already material said Dr Philip Duffy, president and executive director of Woodwell Climate Research Center.

Speaking at ‘Sustainability Digital: A Planet in Trouble,” he said that increasing wildfires, hurricanes and rising sea levels are all signs of change with profound economic and social consequences.

Last year’s extreme hot and dry weather in California is a continuation of a trend feeding into wildfires, while storms in the north Atlantic and rising tides and flooding are also part of a long-term trend. In Australia, trends in wildfires will evolve, threatening the east of the country, the most populated area with the highest vegetation. In the Mediterranean additional months of drought every year will lead to water scarcity, fire risk and have an impact on human migration. Duffy also warned of the impact of rising temperatures on crop failures.

Unstoppable momentum

Melting permafrost will also have a “major impact on life on earth,” said Duffy, who works with governments – as well as some institutional investors including CalPERS and OTPP – to help inform policy decisions. Permafrost is thawing as the Arctic warms, emitting carbon dioxide and methane in a vicious circle whereby the more the frost thaws, so it speeds up the thaw.

“We risk losing control,” he said, explaining that even after humans stop emitting greenhouse gases the warming will continue.

“We don’t know the probability of this, but it is a risk, and a risk we haven’t got to grips with yet.”

Meanwhile, he said a key consequence of climate change is that parts of the world will become difficult to inhabit with implications for migration.

“The potential for large scale migration and political uncertainty concerns me,” he said.

In a sobering message to delegates comprising over 300 global investors with a combined AUM of $12.7 trillion, Duffy explained that when we stop emitting greenhouse gasses, the impacts of climate change won’t reverse – they will just stop getting worse.

However, he stressed the importance of action now, and observed from his vantage of years working on climate change that “people are finally getting it.”

He said there is “no such thing as it being too late” and said strong action now and into the future will push the negative consequences of climate change into the future, making a “liveable” future more likely.

Duffy outlined the challenges of climate capture technologies that remove carbon, explaining that the technology and energy use is expensive. It is easier to slow emissions via man management or natural methods like restoring carbon to agricultural soils and re-forestation.

“It won’t get all the way, but this is something we can do right now and it’s inexpensive,” he said, adding that there is growing interest in agricultural methods that restores carbon to soils.

Duffy’s work includes advising pension funds like CalPERS and Canada’s OTPP on how to evaluate assets through a lens that takes into account physical climate risk.

“When we started this, it was something quite new; it wasn’t something investors were used to thinking about when assessing where to allocate capital.”

Duffy also explained that some regions and countries could benefit in the short term from climate change. For example, Russia and Canada may find more land suitable for agriculture. However, he stressed that long-term “we all lose” because of the impact of migration and political instability.

He urged rich countries, that have contributed most to climate change, to do more to help poor countries which have contributed the least but stand to suffer most.

“Like with COVID, it is in the interests of rich countries to help poorer countries,” he said.

Emerging economies are potentially significant sources of emissions going forward and if they develop their economies using fossil fuels, it will exacerbate the problem.

“It is in our own interests to help them develop their economies with low carbon and help them cope with climate change.”

He concluded that change hinges on increasing wealth but via lower carbon solutions – rather than asking people “to make do with less” – and espoused investor power.

“The financial industry and business sector has a strong political voice if they decide to use it.”

Sharan Burrow, general secretary of the International Trade Union Confederation, is calling on investors to do more to fix what she calls a broken labour market.

In an impassioned call to delegates at “Sustainability Digital; A Planet in Trouble,” Sharan Burrow, general secretary of the International Trade Union Confederation which represents 200 million workers in 163 countries called on institutional investors to do more to protect workers rights.

She said investors can choose to have an impact and shouldn’t put “making a profit” before “dehumanizing workers.”

She said investors need to ensure they are supporting democracy and that their capital is going to build strong companies that contribute to jobs and security. Moreover investors have a stake in repairing the broken social contract between workers and business because they invest workers capital.

A labour market that offers no security for workers or adequate retirement provision is good for neither business, investors or sustainability, said Burrow.

In what she called a “moment of truth,” she asked if business leaders and investors are prepared to reform the current model. She warned of conflict, already visible, if this didn’t happen, and noted that investors willingness to make change is often dependent on change not “effecting their environment.”

Burrow also highlighted the importance of a Just Transition that creates new jobs for those whose jobs disappear in the new economy. She highlights the auto sector particularly, where the transition to a low carbon economy is already having an impact on jobs and skills.

“Labour’s share of income has slumped and so many workers live day to day,” she said, calling for equality of race and gender to rebuild trust. “All investments must have a rights and sustainability lens; ESG is no longer an option.”

Burrow questioned whether global monopolistic companies were sustainable, suggesting they should be broken up.

She said workers need occupational health and safety, a minimum living way and control over the number of hours they work.

Reflecting how the Biden administration will impact workers rights, she noted the conflict inherent in the US between strong unions on one hand and resistance to human rights and labour laws from business that comes from the top on the other.

However, she said Biden was “a friend” to the union movement and would support freedom of association, but that he also had an eye on the economy and the urgent need to transition.

Burrow said that it is impossible to build a sustainable economy that doesn’t include benefits for labour and people. She also flagged worrying challenges in democracy, concluding that “many young people” no longer believe that democracy is good for them.

Nobel Prize winner Professor William Nordhaus, Sterling Professor of Economics and Professor of Forestry and Environmental Studies at Yale University, explains his theory of ‘No Regrets’ whereby companies can integrate ESG at a level that brings real benefits for society but has limited impact on the corporate.

Companies integrating ESG need to examine how they deal with the harmful externalities that they generate. By reducing the damaging spill overs of corporate activity like pollution, but without huge financial costs or damaging shareholder value lies at the heart of ESG integration, said Professor William Nordhaus, Sterling Professor of Economics and Professor of Forestry and Environmental Studies at Yale University.

Speaking at “Sustainability Digital: A Planet in Trouble” the recipient of the 2018 Nobel Memorial Prize in Economic Sciences outlined the arguments in his book “The Spirit of Green,” explaining that ESG holds so many concepts and ideas it is easy to become muddled. By looking at ESG through the lens of reducing externalities that benefit society without real corporate harm brings clarity.

Nordhaus used the analogy of turning down a thermostat to explain how corporates can introduce a policy of ‘No Regrets.’ The heating is still on, just a notch lower so that “we don’t’ feel the difference” but it has a “substantial difference” on externalities.

“We can make substantial contributions to reducing footprints in a win for society at small cost for firms.”

Nordhaus said that many firms achieve a win-win, where good management and governance brings benefits to both the firm and society. Challenges come for companies that act in the interests of society in a way that impacts the company negatively. However, a small reduction in a firm’s carbon footprint has a substantial impact on others. He said that “modest” ESG integration that reduces externalities increases shareholder value in a way that is also a “win-win” that does not mean a company will lose out. It has a benefit for society and comes at a low cost to the firm – and does not trigger a shareholder revolt.

Nordhaus said that investors should choose portfolio companies that apply this principle, selecting companies that reduce their carbon footprint at a low cost and designing portfolios that have lower impact. He said this approach would allow investors to reduce their portfolio imprint “with minimal loss” and he urged investors to “intervene with managers” to design portfolios for lower impact.

Carbon price?

Nordhaus, who outlined his argument for a carbon tax last year, told delegates that he believes a price on carbon is more likely under the Biden administration. However, he said it wouldn’t happen in the near future.

“It requires legislation and a majority in the House and Senate,” he said. He does believe US federal regulations are likely around auto emissions, however.

“I would be very surprised if this was not introduced,” he said.

He also urged governments to facilitate innovation in low carbon technology. The “radical” and “deep change” needed to reach net zero by the middle of the century requires a new landscape of innovation fuelled by a price structure where innovation pays off.

“Profit orientated firms need to have a price structure that reflects this priority,” he said, urging for a price structure that incentivizes private actors to conduct research. “The battery people know what to do; they just need an incentive,” he said.

In broad concluding comments, he said that corporations are increasingly viewed as members of society with economic and ethical obligations. He said ESG integration involves mostly voluntary actions, and said the idea that profits are the “central goal” for businesses is a “misleading compass” that needs correcting. He said containing the impact of climate change is possible if we go about it efficiently and at a low cost, focusing on corporate externalities. “We don’t’ have to go back to the Stone Age,” he said. “You don’t cure a pandemic by holding up in the house. You do it with a vaccine.”