Christian DiClementi: Patrick, many investors say that ESG—environmental, social and governance—concerns, are too specialized, too difficult to quantify, especially in emerging markets. What’s AllianceBernstein’s view?
Patrick O’Connell: We do feel that ESG risks are difficult to quantify, but all investing is a difficult activity. We think that ESG considerations can be done in emerging markets through the opacity in the sector by using a 360-degree view. Talking and engaging with multiple stakeholders, creating a very holistic viewpoint and then quantifying that very challenging ESG information using a proprietary framework. Even though ESG has only become topical recently, we’ve got a track record of doing this for the last six years.
CD: And what does that data and that track record tell us?
PO: We’ve actually come up with a very surprising conclusion. We found that in emerging-market corporations, about two-thirds of the worst performers every year are due to ESG considerations. Emerging-market corporates deal with things like macroeconomic imbalances, sovereign defaults, COVID, but yet two-thirds of the issues are partially driven by ESG considerations. This includes kind(s) of environmental catastrophes or governance issues, like self-dealing owners. We think that ESG risks are real credit risks and that investors need to have robust ESG policies to mitigate these considerations.
CD: Can you walk me through an example that brings that process to life?
PO: Guacolda Energía. It’s a midsize Chilean utility. This company only has coal-fired power plants, which over time are becoming less popular, and it’s losing its clients. Further in 2021, the company was sold to a sketchy local private equity owner who might not have creditors’ best intentions at heart. These factors led bonds to decline by about 60% in 2021. These bonds now trade around 30 cents on the dollar—deep in distress territory.
CD: 30 cents. Wow.
PO: And investors might have missed this back when this bond was issued in 2015. It was originally issued as an investment-grade security and now trades at deep distress values. You can see that ESG considerations, challenged environmental and now a governance problem has led bonds to really underperform, both from a ratings and a bond price point of view.
CD: So Patrick, how could an investor have known about this beforehand?
PO: Investors have to roll up their sleeves, engage with the company, its clients. Investors can talk with the regulator to understand that they want coal to decrease as a part of the matrix. And also a dedicated proprietary scoring framework that brings in all these aspects from different stakeholders, scores them in a proper way and builds portfolios based on this information coming from ESG sources. When it’s all put together in the right way, investors can have an edge in understanding ESG risks before the market and take actions that protect portfolios from these lingering ESG considerations.
CD: Can our same research be applied to highlight opportunities in the market, perhaps opportunities in the same sector in the same country, Chilean utilities?
PO: Yes. The Chilean utility sector makes for a great example. Because you’ve got the case like Guacolda, where things go poorly, but also it gives an opportunity for investors to engage with the rest of the industry. We feel confident that the Chilean utilities will close down about 50% of their coal capacity by 2025, materially greening the energy matrix and reducing that tail credit risk.
Further, they’re investing in renewables at the same time, so the energy matrix will remain in balance and reduce carbon emissions. For investors, this is kind of a win-win: positive environmental outcomes and a more stable, resilient credit.
Further, we engaged with the government of Chile to help them with their most vulnerable citizens. What the system actually came up with is an innovative bond that international investors could fund into, that would help cushion the bills for low-income individuals. We think innovative structures like this offer a great chance for international investors who are ESG aware the opportunity to fund into structures that help both a social and an environmental consideration.