What are the opportunities for ESG in Fixed Income?
Bond funds, with an ESG twist are on the rise. Several funds launched over the past year have focused on fixed income, linking the asset class with key Environmental, Social and Governance (ESG) themes of carbon-neutrality and climate change.
CAMRADATA reports that asset managers are applying the same procedures to bond as they have for public equities and that like equity funds, bond funds can reduce exposure to material ESG risks by screen out issuers.
CAMRADATA’s latest whitepaper – ESG in Fixed Income – highlights the opportunities and challenges ahead for those increasing their efforts in ESG investing.
The whitepaper includes insight from guests who attended a recent virtual roundtable hosted by CAMRADATA, from firms including Aegon Asset Management, Amundi Asset Management, Natixis Investment Managers, Aon, Barnett Waddingham, Hymans Robertson, Russell Investments and Zurich.
The report highlights that the importance of ESG criteria in fixed income investing continues to grow. In terms of supply, the issuance of bonds labelled green, social, or sustainable in the first four months of 2021 topped US$160bn.
Social bond issuance alone is up twelve times compared with Q1 2020. In terms of demand, more of the regulations applied to long-term investors, including asset managers, now explicitly require the recognition and evaluation of ESG factors.
Sean Thompson, Managing Director, CAMRADATA said, “Last year we reported growing evidence that the integration of ESG can create alpha in corporate bond markets and even outperform non-sustainable investments. This trend continues.
“Asset managers are applying the same procedures to bonds as they have for public equities. Bond funds, like equity funds, can reduce exposure to material ESG risks by screening out issuers. Alternatively, portfolios can tilt in favour of the strongest sustainability performers.
“But there are challenges, including whether bond indices are up to the job of supporting sustainable investments,. Our panel explored these themes and shared insight into what the outlook may hold for fixed income ESG.”
The CAMRADATA roundtable began with consultants outlining that ESG integration in fixed income was an essential part of manager research. The consultants were asked if they saw considerable differences in use of metrics by managers; and whether they had to standardise managers’ measures for their own internal ratings.
The managers attending went on to explain their own ESG methodology and were asked whether they engaged for influence or to understand a company better, as a feedback mechanism.
The discussion also looked at the green bond market, which is in its infancy, and how the standardisation of metrics would come in time, along with the behaviour of some issuers when it comes to greenwashing. The final question was, what is required to take asset owners and consultants to the next level in fixed income ESG?
Key takeaway points were:
- One panellist said that the more you delve into internal proprietorial styles, the more you see stronger strategies that have ESG as a fundamental feature. But they noted that ESG data is not free: some managers include more than others.
- Another said they did not have a problem with managers having different calibrations, and that everyone sees things differently. The most important thing is engagement.
- A pension fund consultant said that ahead of standardisation, came the issue of simplification. Some clients, such as lay trustees, need education on technical issues such as climate change and governance structures to be able to make informed decisions.
- The analysis and decisions made around climate risks can vary significantly depending on the maturity of an individual bond. When lending to climate-exposed companies over the longer term, investors typically demand a premium for doing so.
- One panellist pointed out that parts of the energy sector are starting to look like tobacco; the markets are attaching credit risk to these companies, concluding it is becoming more challenging to construct long-dated low-carbon portfolios without foregoing yield.
- The behaviour of some issuers was described by one panellist as “greenwashingesque”, but they noted that resources required to satisfy the eligible criteria are quite high. From the ultimate lenders’ perspective, they added that the green bond market still has the attractive characteristic of being lower beta.
- Green bonds are less than ten years old, but they were doing well. Third party certification of issuer KPIs had to happen, but the most important need was standardisation to make certification understandable to all.
- One panellist noted that the discussion had concentrated on credit but there was need for product innovation in ESG in Asset-Backed Securities, loans, and all other types of debt.
- Two thoughts for the future. Firstly, how investors bring ESG criteria to bear in sovereign bond markets. There was a challenge for the asset management industry on how to influence countries to act more responsibly.
- Secondly, how to make all issuers – corporates and sovereigns – act faster; given that humankind is not reaching its set targets for climate change mitigation, decarbonisation, and rates of loss of biodiversity.
- A final takeaway – it was suggested that asset owners in co-operation with asset managers devise ESG bond indices. These are far more readily available for equities than for fixed income, where index providers had failed so far “to step up.”
- Asked whether these new indices would replace or co-exist alongside existing indices, the panellist replied that the new ESG versions would have to be sector neutral to promote change rather than bypass heavy emitters of CO2.
- Adding that the new indices could be used for both active and passive mandates. Active management in fixed income has many advantages over a passive strategy.
Additional insight is offered in the whitepaper with two articles from the sponsors:
- Aegon Asset Management: ‘How short-dated bonds can help investors to manage climate risks’
- Amundi Asset Management: ‘Greening Fixed Income markets: a challenge of today and tomorrow’
- Natixis Investment Managers: Extracting value from the “Greenium”
To download the ‘ESG in Fixed Income’ whitepaper click here