How to interpret Entropics’ indicators for responsible investments
Starting with the monthly report for November 2015, Entropics will now publish monthly key performance indicators for responsible investments. While still a work in progress, the indicators give an impression at a glance of the RI performance of the fund and, not least, of the benefits to society of cat bonds.
Traditional ESG (economic, social and governance) risks are small, due to the design of cat bonds. However, as the asset class as such is inherently beneficial to society, it becomes all the more interesting to measure the impact of cat bonds on society. Thus, Entropics emphasizes the purpose of a certain cat bond, which is also reflected in the indicators.
The most interesting indicator, as we see it, is thus, the distribution of purposes between different bonds. We currently distinguish between four main purposes of a cat bond:
- Disaster relief, providing funds for exposed regions, mainly in developing economies. These often have parametric triggers, as they are designed to ensure a relatively fast process to release funds if needed. Examples include the MultiCat Mexico cat bond series.
- Public services, providing insurance coverage for public infrastructure. These, too, often have parametric triggers. To date, there are two bonds on the market in this category: MetroCat Re (the New York metro) and PennUnion Re (Amtrak infrastructure).
- Insurer of last resort. In order to ensure that people in exposed region have access to adequate insurance, many US states have set up non-profit insurance or reinsurance companies to provide this coverage for those that would otherwise not have access to insurance. On example is the Florida cat bond Everglades Re.
- General property, which is the majority of all cat bonds on the market. These are issued primarily by reinsurers to back their general obligations.
The “Share of purposes” table in the monthly report calculate these shares, as a percentage of the Fund’s AUM (thus the purposes don’t sum up to 100%, as the Fund holds a certain amount of cash at any given moment).
The indicator “Share of problematic purposes” reflect the share of bonds that specifically cover purposes that have been designated as problematic in Entropics’ Policy for Responsible Investments. This figure should not exceed 10%, and is likely to remain very low for the SEF Entropics Cat Bond Fund as company or industry specific coverage is not common with cat bonds, while they exist in the larger ILS sphere.
What about traditional ESG risks?
While the traditional ESG risks are small, they should still be addressed. Again, as cat bonds are fully collateralized and the collateral is managed by an independent intermediary (the special purpose vehicle), the indicators differ somewhat from traditional asset classes. Entropics assess the ESG risks for the domicile of the SPV, the issuer of the assets where the collateral is invested and the currency of these instruments. Furthermore, we assess the sponsor’s ESG risks. While a sponsor failure would not be as dramatic as in the case of a corporate bond, it could entail lost coupons and reallocation costs. These risks are described in the table “Share of problematic entities”.
To date, Entropics has excluded two bonds from investment consideration, as we do not perceive the purposes of these bonds as beneficial to society. We have identified one problematic sponsor, Turkey, due to the human rights situation in the country. However, the purpose of the bond sponsored by Turkey, the Bosphorus Re, to provide disaster relief in case of an earthquake is not problematic and we assess the risk of a failure to pay premiums on a disaster relief program to be very low, we see no reputation problem and believe the ESG risks are still very low.
How are ESG risks evaluated?
All entities (countries, companies, organisations) are ultimately assessed discretionarily by Entropics’ head of responsible investments. To assist in this assessment, Entropics is currently building a system for monitoring ESG risks. The key performance indicators in the report reflect our assessment, not only the underlying data.
We have two reasons for this approach: (1) It allows us to make assessments even though data may be missing and (2) it allows for continuous monitoring of the entities and assessments based on current events rather than two year old data.
The ESG data for countries will primarily be fetched from three sources (Environmental Performance Index, Social Progress Imperative and Worldwide Governance Indicators), all assembled by respected institutions. The primary source for corporate ESG data will be Bloomberg, where Entropics will use a smaller number of indicators as proxies for the larger perspective. As the sponsor ESG risk is, by far, the smallest risk in terms of impact on the Fund, we believe that this is a reasonable balance between our ambition to perform a thorough analysis of each bond and the work needed to do so.