Distressed credit and a fund focused on slowing down climate change don’t seem like a natural match.
But after two years of research, Sheru Chowdhry, founder and chief investment officer of DSC Meridian (and the former head of credit research and co-portfolio manager at Paulson & Co) has launched the first distressed and event-driven credit hedge fund investing with environmental, social, and governance goals.
In line with that, DSC Meridian, a long-short corporate credit manager, has hired Paula Luff as head of ESG research and development to run the new Climate Action Fund and help the firm shift to meet ESG standards. Luff has been on both sides of the ESG fence: She built an ESG platform for asset manager Inherent Capital and has developed sustainability programs for corporates. Under Luff, the Climate Action Fund has a dual mandate: Match the returns of the high-yield sector and lower the carbon footprint of the companies in the portfolio by aligning them with the Paris Climate Agreement and UNPRI.
Greg Neal, head of ESG investing at HFR Investments, said HFR’s surveys show huge demand from investors for this type of strategy, but few options. At the same time, it’s not always clear how a credit fund can influence a company’s ESG efforts. “When I first thought about it, I didn’t see the connection. But in our very first conversation they said, ‘Disregard every other investment scenario except restructuring. If we are a senior credit holder, we have power and we can use it for whatever we want.’ That made sense,” Neal told Institutional Investor.
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Chowdhry said it took some time before he fully embraced the idea of a credit hedge fund with an ESG focus.
“We had two different approaches to investing, one at the top of the credit cycle and one at the bottom of the credit cycle. Our journey began when one allocator came to us and said, ‘We like your approach in credit, but we want to see if you can provide the solution to us with an ESG lens,” said Chowdhry in an interview.
ESG made sense to Chowdhry in equities, because the returns generated from sustainable investments belong to shareholders. In fixed income, it’s harder to measure the impact of engaging with ESG issues on the holders of securities that have a limited duration and which all mature at par, he said.
“The ‘Aha’ moment came when we realized that there is more and more disclosure and data coming from companies around ESG issues. And two, we as stressed and distressed credit investors actually engage with companies on capital structure issues and we could engage with companies similarly on ESG. Even though there is very little disclosure in the high-yield space right now, it’s growing. If we could move the envelop in that direction, that would be a job well done,” said Chowdhry.
Salvatore Cordaro, Co-CEO of Investcorp-Tages, said it’s still early days for credit and ESG. “This team has a rare combination of skills: credit and ESG. Some investors already have equity portfolios that are fully compliant with ESG. In fixed income and credit, it’s more complex. If you can get this right, you will get higher returns and lower risk,” he said in a telephone interview.