Embedding responsible investment into the fixed income investment process

There are a number of fundamental building blocks, regardless of asset class, that all investors should consider when setting their organisation up to implement responsible investment.

Including ESG considerations in investment decisions, engagement and reporting requires different teams with different capabilities to collaborate effectively. Cross-functional working groups, steering committees or ESG centres of excellence should include analytical, marketing, risk management and senior-level staff to aid implementation. In contrast, a bolt-on or ad hoc approach to ESG rarely has the desired results, and clients who are familiar with RI practices are unlikely to consider such approaches credible.

“For us, systematically factoring in ESG is a relatively new area, and BlueBay has seen a lot of client interest. The question was: What are we going to do about ESG and how to integrate it into investment process? We decided that ESG really is just another risk. By focusing on the risk aspect first of all, ESG could then sit somewhere clearly in a risk department and be driven from there.”

Dominique Kobler, BlueBay Asset Management LLP

“Our portfolio managers now have an objective that says integrate ESG, and that objective flows into their annual assessment.”

Manuel Lewin, Zurich Insurance

Key considerations for embedding responsible investment with the organisation

Encourage staff to engage with RI networks (e.g., PRI Regional Networks, Sustainable Investment Forums and UN Global Compact Networks).
Encourage minimum RI requirements across business units (e.g., ESG scores should be discussed in sector reviews and quarterly meetings).
Review effectiveness of ESG-related analyst recommendations.
Ensure internal capacity to gauge the quality of external research and issuer ESG disclosure.
Appoint external advisory panel to guide on more complex ESG issues.
Train staff on ESG and include ESG understanding in competency frameworks.
Encourage ESG analysts to produce regular ESG research for fixed income teams.
Encourage ESG experts to work with fixed income analysts on a regular basis, and encourage analysts to seek insights of ESG research teams.
Integrate ESG analysis, red flags and watch list details into internal IT platforms analyst notes, templates and scorecards, and share ESG information with equities and other teams.

Investors face a challenge of identifying consistent and comparable ESG data that provides strong signals of creditworthiness. ESG research providers, universities and non-governmental organisations (NGOs) offer raw ESG data on issuer/sector/ country-related analysis or ratings, customised research, risk mapping and indices. ESG data from sovereigns typically comes from the UN bodies, the World Bank, the International Energy Agency (IEA) and other intergovernmental organisations.

Investors developing proprietary ESG scores or ratings typically start with a broad set of indicators and narrow these down over time based on results from back-testing. Individual ESG factors are typically weighted as part of an overall ‘ESG score’ subject to an investor’s opinion on their materiality relative to sector or region; governance factors are typically given more weight than environmental or social issues. Carbon intensity, water scarcity and waste management are common environmental indicators for corporates. Corruption, political tensions and energy intensity are commonly used indicators for sovereigns.

“We have a proprietary credit research database which houses all analysts’ research and review of credits we own. ESG risk assessment forms a key part of the review process and is captured in this database.”

Toni Spencer, Colonial First State Global Asset

Training

Training options range from broad, sustainability-related courses to dedicated RI courses or units within financial courses. Some investors may have the capacity to develop their own in-house training.

The PRI Academy provides CFA-accredited online training on how ESG issues impact company performance, shareholder value and investment decisions.

“The way ESG issues impact, the financial bottom line can be very complex. What does climate change mean for a global retailer, a car manufacturer, or a bank? How much credit spread is a good climate change policy worth? How do you reflect climate risk in a discount rate? There are generations of portfolio managers out there who haven’t been trained to understand these issues, and you can’t just expect everyone to now deal with them effectively. The starting point has to be training.”

Manuel Lewin, Zurich Insurance

Developing replicable RI processes for integration, engagement and reporting

Few asset owners prescribe how they want to implement RI within their organisation, as no two are the same. Nevertheless, they do want to see a replicable process that has demonstrable results. A policy without sufficient ESG data or analytical resources to back it up will not be successful, neither will an ad hoc approach. Reporting on the process itself is key to engaging with clients, and this should be seen as an iterative rather than fixed process.

“I’ve found within the employees of Mariner, people applaud us for having a view that we’re thinking about these issues.”

Bracebridge Young, Mariner Investment Group

Challenges

Implementing RI in fixed income has its challenges, ranging from the technical difficulties of ESG integration to the potential organisational changes.

The lack of voting rights is a barrier to effective engagement.
Current lack of consensus on which ESG indicators give the most insights.
Fixed income performance perceived as less esensitive f to ESG factors than other asset classes; many struggle to see the business case for RI.
Incentives to integrate ESG can be limited by regulation that restricts overseas investment (e.g., Latin America), market scale or conditions (e.g., demand outstrips supply) and asset liability management (ALM).
The lack of ESG research coverage for high-yield, emerging market and non-listed issuers remains a challenge.
Reporting on ESG factors for multiple segregated mandates may require additional resources.

“[ESG integration] strengthened the need that we had to have a comprehensive framework to ensure people were analysing countries in a similar or same fashion.”

Rob Drijkoningen, Neuberger Berman