Summary
The Portfolio Managers responsible for managing municipal portfolios within an asset management company needed ESG leadership data on municipal bond issuers. This was crucial to align their selection approach with their investment strategies, enabling them to identify ESG-related risks and opportunities. This data also accounted for potential reputational risks or credit rating changes linked to ESG concerns.
The Challenge
The Asset Management firm developed an in-house model framework using the guidance of the International Capital Market Association (ICMA) Group’s Mapping of SDGs to Green Social and Sustainability Bonds. This method takes the sector-specific ESG factor data of municipal bond issuers and scores them from 1 to 5 based on their performance relative to their peers. The model's objective is to identify issuers demonstrating excellence in environmental stewardship, governance, and positive social impacts, by considering various ESG outcomes pertinent to their sector. The resulting scores guide portfolio managers in selecting issuers for their investment universe, aligned with their portfolio strategy. Given that the model impacts approximately $215 billion in assets under management (AUM), it was critical for the model to be thoroughly reviewed to ensure its effectiveness and reliability.
Our Solution
Evalueserve conducted a comprehensive validation of the model using model risk management procedures. This involved a meticulous technical evaluation of the issuer scoring methodology, benchmarked against scientific research, industry norms, and alternative approaches. The model's processing components underwent a thorough assessment, and its implementation was scrutinized through replication, sensitivity analysis, and stress testing. Evalueserve's contribution was significant, as it uncovered potential risks and biases that could inadvertently affect the asset manager's investment strategy. This was particularly relevant due to the absence of established scientific consensus or industry standards concerning ESG scoring methodologies.
Business Impact
Evalueserve's solution ensured the effectiveness and reliability of the model, especially given the absence of standardized ESG scoring methods. This gave the portfolio managers confidence in their decisions. Moreover, having ESG information about issuers empowered the firm to create innovative products in response to increased client interest in ESG and make responsible investments while maintaining diversification.
Conclusion
Evalueserve helped an asset management firm tackle the challenge of obtaining ESG leadership data for municipal bond issuers. This data was crucial for Portfolio Managers to align their selection strategies with investment goals, identify ESG risks, and account for potential reputational and credit impacts. Given that the company’s in-house model’s $215 billion AUM impact, a comprehensive review was imperative. Evalueserve's contribution was substantial, conducting a rigorous validation through technical evaluation, replication, sensitivity analysis, and stress testing. The team uncovered potential risks and biases, ensuring the model's effectiveness in an industry lacking standardized ESG scoring methods. This bolstered portfolio managers' confidence and empowered the firm to innovate in response to client interest in ESG, maintaining responsible diversification.
