Can local authorities invest for income in a sustainable way?

Photo: Harrison Moor, Unsplash.

Sponsored article: Lesley-Ann Morgan examines the integration of ESG into a multi-asset investment process.

When many of us think about local authority treasury investing, we might think about the shorter term needs. However, some treasury departments also invest a portion of their assets for the longer term. Like all investors looking for yield over a longer time horizon, higher risk assets have to be considered due to the extremely low yields available from safer developed market bonds. The broader the range of assets a local authority can employ, the better diversified a portfolio can be—meaning risk can generally be better managed.

But diversification can only take you so far. This is evident now, because the income available from multiple asset classes is becoming impaired: government bonds offer low yields, equity dividends are being cut, and the recession is causing credit defaults.

So, it is helpful to identify those assets whose income might, in our view, be less at risk of impairment. We believe that by considering ESG (environmental, social and governance) from an active management perspective when income investing, we can find companies with less debt and good earnings potential.

Those companies are less likely to cut dividends and thus be more suited to an income portfolio.

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ESG integration is becoming increasingly important, and while some may believe that it doesn’t pay to include ESG, we believe that ignoring it is a risk that all asset owners and fiduciaries need to recognise

Through the work we have done at Schroders on integrating ESG into our multi-asset investment process we identified 5 factors that are required to apply ESG across multiple assets:

• Clear philosophy. You need a clear idea of which parts of E, S and G you want to incorporate, and the time horizon over which you expect these to play out;
• Make the time or make someone else make the time. It takes significant resource (your own or outsourced) to manage an ESG approach successfully;
• Education. This can’t be delegated and needs ongoing attention.
• Implementation. Ensure the managers you employ understand both your income requirements and ESG philosophy;
• Measure. It is critical to be able to measure and ensure that the strategy is doing what you expect from both an income and ESG point of view.

In our experience of going through this process, we have leant that incorporating ESG takes time. We have also learned:

• Everyone needs to evaluate and decide for themselves. Just telling our investors that they must incorporate ESG was never going to be successful. Now that they have each taken the time, they have embraced the concepts and our approach.
• Education is imperative. Access content from videos and online content. Unlike investment knowledge, this topic and the information available, keeps changing so you need to keep up to date.
• Recognise this is tough. Good data on ESG hasn’t been around long enough to provide a definitive answer. Learn, analyse, measure, debate and ultimately agree an approach.

For those that have a longer investment horizon for a portion of their assets, we have demonstrated that active sustainable income investing is not only possible but could be advantageous in a post-Covid world where dividends are being cut. Ignoring ESG may result in unintended risks being taken with local authority assets.

Lesley-Ann Morgan is head of multi-asset strategy at Schroders.