An Innovative Research Approach: Using ESG Integration to Enhance Risk Controls

By Nick Erickson, Vice President, Portfolio Management

As the effects of climate change become more prevalent, the potential for unexpected and significant impacts to credit risk has increased for municipal issuers. Rising sea levels, droughts, wildfires, and deep freezes, to name a few, have recently put additional strain on government budgets, especially those that are both structurally and financially ill-prepared. Whether it’s an unexpected deep freeze in the heart of Texas or increasingly common wildfires in California, these emerging risks need to be considered when assessing the credit quality of an issuer.

As the environment and society changes, so too must our investment analysis, and the consideration of environmental, social, and governance (ESG) factors provides crucial insight. Sage’s municipal ESG integration process evaluates current and forward-looking ESG risks and opportunities that are not utilized in traditional financial analysis but may affect an issuer’s overall credit risk. The following are examples of municipal projects that have an ESG benefit.

Environmental Factors: Preparing for a more unpredictable future

  • These municipal projects focus on increasing the capacity and ability of a municipality’s infrastructure to handle significant climate events. One example is a project that is constructed to supply clean drinking water to a growing population, even in times of severe drought, for the duration of the project’s life.

Social Factors: Supporting the population during and after major climate events

  • These municipal projects focus on improving the resiliency of and increasing the support for basic public needs and programs that could be impacted by a major climate event. This includes projects that upgrade and reinforce facilities that provide basic needs, such as electricity and wastewater services, during times of inclement weather.

Governance Factors: Analyze the fiscal health and financial preparedness for climate events

  • These municipal projects consider a city’s overall fiscal health. A strong balance sheet can indicate that a municipality is better able to support its population in the preparation for and capacity to handle climate events.

When used in conjunction with traditional credit research, ESG factor analysis enhances Sage’s research capabilities to potentially spot credit events before they occur. Historic credit trends have shown that municipalities with better fiscal health tend to have higher credit ratings and are less likely to be downgraded. In addition to this benefit, those same issuers will be better prepared to handle the occurrence and aftermath of climate-related events, providing an additional layer of credit support.

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

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