The Markets October 21, 2014

Sustainability Screens Can Boost Corporate Bond Portfolios

The use of sustainability ratings can improve the risk-return ratio of investments in corporate bonds, according to Oekom Research’s new Corporate Bonds Study.
Reported by

The financial research firm says its Corporate Bond Study is “the first comprehensive analysis on sustainability and corporate bonds worldwide.” The research effort tells a compelling story about sustainability and performance considerations when investing in corporate bonds, Oekom says. This is important for retirement plan fiduciaries serving Employee Retirement Income Security Act (ERISA) plans—as the law dictates sustainability decisions must come second to performance considerations for investments in defined benefit and defined contribution retirement plans.

Corporate bonds are enjoying increased popularity among various types of investors, including institutions and retirement plans, due in large part to persistent low interest rates on investment-grade government bonds. Lower interest rates result in lower yields from government bond securities, driving investors to corporate bonds. But not all corporate bonds are created equal, Oekom explains, and investors are seeking more effective means of building corporate bond portfolios. Researchers at Oekom suggest those investors who take account of how bond-issuing corporations deal with the industry-specific challenges of sustainable development will have clear advantages in terms of the likelihood of default and the interest return on bonds investments.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

For the majority of institutional investors, bonds continue to form the backbone of their capital investments, Oekom says. Corporate bonds, in particular, have gained importance in recent years, both in the U.S. and globally. In Germany, according to the latest surveys by the sustainable investment researcher Forum Nachhaltige Geldanlagen (FNG), 23% of sustainably invested capital is invested in corporate bonds, while in Austria the figure is as high as 50%. Calculations by the industry association Eurosif put the proportion for Europe as a whole at as much as 21.3%, Oekom adds.

Another reason sustainability is an important corporate bond screening criteria is that increasing numbers of companies are issuing bonds as an alternative to obtaining financing through bank loans. As a result the range of bonds available on the market has also risen significantly in recent years, Oekom says. The success of a bond portfolio in this environment is essentially determined by the extent to which the portfolio manager succeeds in avoiding the partial or complete default of individual bonds. For this reason, selecting issuers on the basis of risk is particularly important when it comes to corporate bonds, heightening the importance of sustainability factors.

The role that sustainability ratings can play here, Oekom’s analysis shows, is that better sustainability performance and a better sustainability rating go hand in hand with a higher equity ratio for corporate bonds. The firm has developed a metric—the Oekom “Prime” status—as a basis for assessing sustainability and identifying bond-issuing companies with above-average-equity ratios.  

As the firm explains, the Oekom Prime status is awarded to companies that meet industry-specific sustainability management requirements. The equity ratio can be interpreted as an indication of the ability of companies to meet their obligations arising from the issue of their bonds; in other words, the payment of interest and the repayment of the capital, Oekom says.

The study also examined the question of how far sustainability ratings go towards explaining or even determining the level of interest on corporate bonds. One finding was that companies with an above-average sustainability rating have a lower credit spread and are therefore considered by investors to be less risky. The credit spread here is a markup in terms of yield on the risk-free interest rate, Oekom explains.

The higher investors gauge the risk of a bond, the higher this risk premium, which the issuer has to pay to investors, will be. At the same time, taking sustainability ratings into account means that you can make a significantly better evaluation of whether a credit spread is appropriate from a risk perspective and in this way identify the best corporate bonds from the risk-return point of view, Oekom suggests.

The Oekom Corporate Bonds Study was sponsored by Ampega Investment GmbH and Bankhaus Schelhammer & Schattera KAG, together with other asset managers.

The Markets October 20, 2014

DC Participants Get Jumpy on Equity Holdings

After an especially quiet nine-month start for 2014, the first half of October saw a major upswing in 401(k) participant trading activity, according to Aon Hewitt.
Reported by

Aon Hewitt tracks 401(k) account activities of nearly 1.3 million participants through the Aon Hewitt 401(k) Index. Rob Austin, director of retirement research at Aon Hewitt, tells PLANSPONSOR that the first 13 days of October brought five days of “moderate” or “high” trading activity. To put that in perspective, from January through September 2014, there had been only 12 total “moderate” or “high” trading days among 401(k) plan participants.

“Up until this point 2014 was shaping up to be an incredibly light trading year overall,” Austin says. “Then all of a sudden in the first few weeks of October we saw five days that came in above normal. What was going on? It’s due to the stock market swings, that much is clear.”

Want the latest retirement plan adviser news and insights? Sign up for PLANADVISER newsletters.

Indeed, the highest trading days for 401(k) participants so far in October have clustered right on and after the days when the S&P 500 lost 1.5% or more. When individuals were making trades, they tended to move from equities and into fixed income, the index shows.

Austin says he is not surprised that the biggest trading days came right after stock market drops, nor that participants favored fixed income on the days when trading volume came in above normal levels.

“We experienced a few daily declines of around 2% so far in October, and clustered right around those days we saw a lot of activity—people were clearly saying, ‘Get me out of here, I don’t want to be in this volatile market,” Austin observes. “For the most part they are selling equity and buying fixed income.”

Strikingly, this participant behavior runs counter to much of the advice being shared by investment professionals and consultants heading in to the end of 2014. Russell Investments, for example, just published its fourth-quarter 2014 global investing outlook, which provides updated strategy and guidance for multi-asset portfolios via Russell’s global team of investment strategists.

While investors are currently experiencing the third-oldest bull market in the past 50 years, Russell’s strategists say we are not likely to face a major turning point in the near future. They maintain the core investment strategy views stated originally in their 2014 Annual Outlook—characterized by a moderate preference for equities over fixed income, a liking for credit, and a bias against exposure to rising long-term interest rates.

Russell researchers admit that volatility has been increasingly recently based on geopolitical events and concerns about slowing global growth, especially in Europe and other non-U.S. markets, but it has not been enough to derail an equity preference for individual investors or institutions. Against this backdrop, Austin says it is clear that some 401(k) participants are letting their emotions get the better of them when it comes to setting and executing long-term investing goals.

He says the Aon Hewitt index shows participants’ growing worries about potential equity losses are resulting in increased and potentially inappropriate allocations to fixed income. For example, looking at October 14, when the S&P 500 went down 1.65%, about 90% of trades executed the following day were to fixed income, Austin says.

“It’s usually the case that when we see something like a 2% drop or more in the equity markets, a vast majority of trades placed the following day are moving from equities over to fixed income,” Austin explains. “We also find that after the stock market goes up a little bit, we see a propensity for people to move more into equities. It’s not nearly at the same volume, but we do see an uptick.”

This means that participants are being reactive to the markets, Austin says.

“Ultimately it’s a harmful behavior—they’re basically selling equity after it’s reduced and buying equity after it’s gone up,” Austin explains. “So that’s really just the old adage of buying high and selling low. That is self-defeating behavior to some extent.”

The phenomenon is as unfortunate as it is dependable, Austin adds.

“We have found consistently over time that, whenever we see a market correction and stocks start to lose some ground, people in 401(k)s tend to be more active and they tend to move towards fixed income,” Austin says. “This is not surprising, but it is something that we are somewhat disappointed to see whenever there is a bit of a pullback from Wall Street.”

«