In the past years the focus both from investors and regulators on the inclusion of environmental, social, and governmental criteria in the management of portfolios has grown significantly. Approaches taken in the investment industry vary widely and range from applying ESG filters or overlays to integrating these criteria into the investment process itself. For MacKay Shields High Yield Group, these qualitative ESG factors are an integral part of their bottom-up investment process.

MacKay Shields High Yield Group believes that ESG related factors, like any risk factor, can have a material impact on the long term return and risk profile of both individual securities and portfolios in aggregate. The team employs a research intensive, bottom-up, value oriented approach to investing in the high yield market with a particular focus on downside protection. As such analysing environmental, social, and corporate governance risks, are at the core of the credit-driven investment process.

Evaluating Downside Protection

Due to their asymmetric reward and risk profiles, investing in high yield bonds requires special attention to downside protection. The team looks for that additional cushion, or “margin-of-safety” through asset coverage. To consider investing in a high yield security, it requires the asset coverage to be at least 1.5x. This investment process imposes a discipline that keeps the team focused on credits with downside cushion and significant margin-of-safety.

Risk Factors in Focus

Central to the approach is in depth security specific research to identify attractive investment opportunities and associated risk factors unique to any particular investment or to the portfolio in aggregate. Risk factors can come in a variety of ways and may take many forms. They could include, among other things, technological change, demand/supply characteristics, company positioning, undue leverage, regulatory issues as well as environmental, social, and governmental related factors. Each of these, along with an analysis of probabilities and margins-of-safety, are incorporated into the research and decision making processes to understand the long term value of a company.

Proprietary Research is Key

The High Yield Group utilizes their proprietary fundamental research, supplemented by ESG screening tools and rating systems, to identify ESG risk factors in their clients’ portfolios. Each senior investment professional will address and document any ESG related risk factors associated with an investment, how the company’s management is responding to them, how the firm is managing them and what the downside risks are associated with it. The Group then formally categorizes investments into internal ESG Risk categories to quantify these risk and provides ESG reporting for clients with ESG considerations.

The determination of security inclusion in a portfolio is always an assessment of the risk-adjusted return potential versus other investment alternatives, as well as the impact on the return and risk profile of the portfolio in aggregate. The High Yield Group believes that the ESG research process should be integrated, transparent and verifiable. For further details about the Group’s approach to address ESG specific risk factors in their investment process, please refer to the High Yield Group’s ESG policy statement.

The longstanding experience and industry relationships of the very tenured portfolio management team are key in having a deep knowledge of the companies and understanding their environmental, social, and governmental risks.