{"id":19577,"date":"2020-09-16T09:45:55","date_gmt":"2020-09-16T13:45:55","guid":{"rendered":"https:\/\/www.benefitscanada.com\/news\/considerations-for-integrating-esg-into-fixed-income-149895"},"modified":"2020-09-16T09:45:55","modified_gmt":"2020-09-16T13:45:55","slug":"considerations-for-integrating-esg-into-fixed-income","status":"publish","type":"post","link":"https:\/\/blog.lifeinsurance-orleans.ca\/index.php\/2020\/09\/16\/considerations-for-integrating-esg-into-fixed-income\/","title":{"rendered":"Considerations for integrating ESG into fixed income"},"content":{"rendered":"
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Kelsey Rolfe<\/span> | September 16, 2020 <\/p>\n

Environmental, social and governance factors are highly relevant to fixed income investment outcomes, but integration is complicated by the variety of issuers within the asset class.<\/p>\n

For corporate fixed income, integration is quite simple. Issuers could use the same frameworks as their equity counterparts, such as the Sustainability Accounting Standards Board\u2019s materiality map, said Joshua Palmer, a fixed income, hedge fund and ESG researcher at Willis Towers Watson, in a webinar hosted by FTSE Russell, Willis Towers Watson and Beyond Ratings last week.<\/p>\n

However, he noted, challenges exist around the longer time horizon for investments, lack of proxy voting options and different levels of engagement with management. <\/p>\n

Read: North American investors closer to falling in line with global counterparts on ESG: survey<\/a><\/strong><\/p>\n

The performance of national economies are linked to how and why their governments conduct themselves, noted Sylvain Chateau, co-founder of Beyond Ratings and global head of sustainable investment product management at the London Stock Exchange Group.<\/p>\n

\u201cIt\u2019s actually governments that set the playground in a way and corporates have to play in it. And governments do change, so there\u2019s not necessarily continuity in how we define the playground. There\u2019s a lot of different ways that are used by governments to actually reach objectives for climate, carbon purposes or a number of sustainability items. Typically, it would be through a regulatory environment \u2014 through laws, taxes, incentives, subsidies and so on \u2014 which of course makes a very different framework for analysis.\u201d<\/p>\n

Institutional investors have limited ability to pressure governments to meet sustainability objectives, added Chateau, noting the time horizons of these fixed income investments are typically 10 years or more, when ESG risks may begin to materialize. \u201cIt\u2019s actually interesting to link that to the materiality of the risk and how it could materialize in this time horizon.\u201d<\/p>\n

Read: Will social bonds\u2019 popularity grow with coronavirus recovery?<\/a><\/strong><\/p>\n

Sovereigns\u2019 ability to issue in local and hard currency also adds a \u201clayer of complexity in trying to work out the material ESG risk factors to the performance of your investment,\u201d said Palmer.<\/p>\n

To date, fixed income has been less affected by material ESG factors due to a combination of its position, capital structure and maturity, he noted. While headlines about human resources issues at a public company could impact its reputation and be quickly priced into its stock, a fixed income investment that\u2019s a few years to maturity may not see its price move under the same conditions.<\/p>\n

\u201cI think ESG risk factors are slightly less material to the investment performance of fixed income in certain circumstances, but you have to attack this problem from multiple angles.\u201d<\/p>\n

Material ESG risks tend to differ across issuers, with sovereign risks centred on economic growth and governance, said Palmer. \u201cYou could have a very rich sovereign with quite a poor record on human rights, but it\u2019s unlikely to impact financial returns in the future.\u201d<\/p>\n

Read: How is fixed income faring amid renewed market volatility?<\/a><\/strong><\/p>\n

Chateau argued ESG factors can be material to these investments. His firm built a model looking at the correlation between ESG performance and a number of market indicators, including the credit default swap spread. It found sovereign debt instruments with higher ESG scores correlated with lower implied credit default swap spreads.<\/p>\n

\u201cThis is interesting in how we can use ESG factors from a financial risk analysis perspective and . . . [there are] two ways of using it \u2014 as an early signal of macroeconomic imbalances, projecting future debt crises . . . and also having a better sense of the cost of borrowing.\u201d<\/p>\n

Looking at the framework itself, ESG indicators differ for corporate and sovereign issuers, with the latter being considerably more creative. While corporate issuers would report scope one, two and three carbon emissions, for example, institutional investors would need to look at carbon produced and consumed in a sovereign issuer\u2019s territory, as well as its carbon trade.<\/p>\n

This becomes particularly important in multi-asset portfolios, where investors need to reconcile the different ways of analyzing corporate and sovereign issuers. \u201cWhat we need to do is . . . to find metrics or ratios that look similar, because they tend to carry the same kind of information,\u201d said Chateau.<\/p>\n

Read: What\u2019s keeping ESG rankings so convoluted?<\/a><\/strong><\/p>\n

For example, looking at an issuer\u2019s carbon footprint, investors could consider the ratio of carbon dioxide emissions to either enterprise value or sales on the corporate side and the ratio of CO2 emissions to debt or to gross domestic product on the sovereign side.<\/p>\n

Double-counting presents a major challenge, noted Palmer. \u201cWe think of it as an attribution problem. If you have a portfolio of sovereign bonds and corporate bonds, what\u2019s the range there of carbon emissions? How much is due to sovereign? How much is to corporate and the consumer that might also be creating some sort of a carbon footprint?<\/p>\n

\u201cIf you\u2019re trying to reduce the carbon footprint of your overall portfolio or move the portfolio in line with some sort of two-degrees future scenario, these are the kinds of questions you need to be asking.\u201d<\/p>\n

Palmer suggested coming at the portfolio from multiple lenses, such as looking at ESG score by type of investment and credit rating, reviewing the best and worst performing credits, as well as the impact of the holding and what percentage of investments have positive externalities.<\/p>\n

Read: Institutional investors increasingly see ESG as source of alpha: survey<\/a><\/strong><\/p>\n

Read the full article at BenefitsCanada.com<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

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