Engagement is particularly key for high yield and emerging markets, where the borrowing companies are less likely to have equity outstanding. However, these companies can also be less aware of investors’ concerns given their lack of exposure to equity-side engagement.
In recent years, as returns have become harder to find, high yield investors often complained of worsening of covenants in the high yield market, driven in large part by the strong demand for higher-yielding debt. This suggests engagement has not always been effective even at the issuance stage.
However, with the interest rate cycle at a turning point, engaging with borrowers may become easier as the cost of capital increases and companies find they need to be more conscious of how their lenders expect them to behave.
Interestingly, investment houses that have both equity and fixed income capabilities report finding engagement easier because they can leverage their equity holdings to influence management in the interests of both equity and debt holders. Fixed income roadshows, for example, often give bondholders access to a company treasurer or head of investor relations, but often not the critical C-suite members with whom engagement would naturally be more effective.
BMO Global Asset Management has been running its equity engagement programme since 2000. “Access is defined by the quality of relationships,” says Yo Takatsuki, associate director, governance and sustainable investment. “It helps if you have a significant equity holding.”
SHARED INTERESTS
Better engagement between companies and their debt providers is in both parties’ interests. Long-term creditors want the companies they are crediting to remain financially sustainable with enough cashflows to service their debt and to maintain their credit quality.
Because companies typically refinance maturing debt, it becomes – much like its equity counterpart – a form of permanent capital. It is in companies’ interests, therefore, to nurture a loyal base of creditors prepared to provide cost-effective debt capital as and when it is required. This will prove particularly critical during periods of market stress.
“Companies that engage with their bondholders could help reduce their cost of capital,” according to Bluebay’s Ngo. “It could also help them raise debt, increase investor loyalty and reduce volatility. Good management of ESG factors can be used as a proxy for the quality of management.”
CONVERGENCE OF INTERESTS
The convergence of interests between bondholders and issuing companies also works in shareholders’ favour. A company’s ability to access cost-effective capital and reduce any volatility will reflect well on its share price and drive down costs, a good thing for those wanting a company to deliver earnings growth, dividend payments, capital retention and capital appreciation.
Over longer time horizons debtholders and shareholders have a shared interest in the long-term sustainability of the firm. Both benefit from good corporate governance and promoting healthy governance practices. “As soon as a long-term outlook is applied, the interests of equity and bond holders become much more aligned,” the PRI’s Beeching says. “This is why we’re trying to get investors away from taking a short-term view.”
While bondholders might find it harder to influence companies than shareholders, given the relative scale of bond versus equity markets, creditors can bolster investor stewardship significantly by increasing the collective clout of the assets under management by engaging with a company.
“On the whole, creditors and shareholders have something of a symbiotic relationship – at least in a going concern,” says BMO’s Takatsuki. “It comes down to ‘financial flexibility’, which is a vital part of credit analysis. Shareholders want companies to be able to access cost-effective debt to fund short and long-term assets, while creditors want firms to be able to attract equity capital to strengthen their solvency and financial position.”
