We are pleased to introduce The Investment Intelligence Podcast, where experts discuss all things investing, from recent market developments, to strategy, sustainable investing, asset allocation, risk management and more.
ESG factors have historically been more commonly associated with equity investments, but the past year has seen a significant change with fixed-income investors pushing for ESG factors to be appropriately and demonstrably integrated into investment analysis and risk decisions.
Integrated ESG means the inclusion of environmental, social and governance factors in all investment process and risk decisions
The ESG focus relating to fixed-income investments has mostly concentrated on downside mitigation, but there is an opportunity to generate positive alpha from companies with improving and transitioning ESG profiles
A fully integrated ESG process draws on individual and collaborative expertise from diverse research teams covering ESG, equity and fixed income
The market has yet to adopt a common approach, with a debate around the merits of exclusion strategies compared with integrated ESG’s ability to invest and engage with issuers on a transitional path
Sustainable investing – which incorporates environmental, social and governance (ESG) factors into investment decisions and targeted investment outcomes – has transitioned from a trend to the mainstream over the past several years. It has become a core consideration for investors as they seek ways to enhance performance and manage risk, while increasingly targeting non-financial goals.
By considering ESG factors, investors can achieve a more expansive analysis of the risks to which companies may be subject. At the forefront of this analysis is climate change, but there is rising pressure on companies to disclose and demonstrate a consideration of broader ESG factors.
In the past, engaging with companies and formally incorporating these factors was perceived as the preserve of equity investments. But the surge in bond issuance in recent years has coincided with heightening investor focus on sustainability, and fixed-income investors are engaging more fully with issuers and adapting investment processes in line. One outcome of this evolution has been the increase in issuance – and issuers – of green bonds.
The primary ESG approaches
At Allianz Global Investors we employ three primary approaches under the umbrella of sustainable investing: integrated ESG, SRI (sustainable and responsible investing) and impact.
Integrated ESG portfolios have no restrictions on their initial investable universe, but there is a formal infrastructure to ensure investment decisions include ESG considerations. Further, portfolio managers must provide explanations for any holdings that are either rated low, or not rated at all by global index provider MSCI .
SRI involves the application of preliminary screening filters to remove issuers exposed to non-sustainable activities, creating a smaller investable universe. That universe will be analysed using a proprietary model to rate each issuer from worst to best in class; selection is then skewed towards the best rated.
Impact involves investment in companies generating an intentional and identifiable social or environmental impact along with financial returns – this strategy includes the likes of green, SDG and transition bonds.
All three strategies involve the collaboration and leveraging of asset class-specific research teams (for example, equity or fixed income) with the specialist ESG analysts, coupled with an active approach to engagement and stewardship. This multi-stakeholder process allows for a more informed approach to sector and company investing.
Increased disclosure supported by research
The asset management industry as a whole has embraced sustainability. By year-end 2018, over 2,000 asset owners with total assets under management of around USD 90 trillion had signed up to the United Nations Principles of Responsible Investing (UNPRI), which promotes six guiding principles1 for the incorporation of ESG issuers into investment analysis. These cover ownership policies and practices, engagement to seek improved disclosure and actively promoting the implementation of these principles. In addition, there is growing focus on the adoption of other UN initiatives, like the Global Compact2 and the 17 Sustainable Development Goals3. This shift has helped drive the momentum of ESG within fixed-income investing.
While the potential upside of a bond is
limited, the downside can be significant
in cases of default, so identifying
potential risks is key, and many of these
have ESG factors at their core
This momentum has also affected practices among issuers. Investors now have greater expectations around how issuers should disclose ESG factors, along with transparent and actionable KPIs (key performance indicators). As greater transparency becomes commonplace, formal incorporation of these factors becomes more granular, and those failing to meet investor demands risk either more limited or more expensive access to capital markets.
An integrated ESG approach means issuers’ own disclosure is backed up by comprehensive proprietary research. Fixed-income assets are characterised by an “asymmetric” return profile – while the potential upside of a bond is limited, the downside can be significant in cases of default. As a result, identifying the relevance of potential risks is key, and many of these have ESG factors at their core.
This progress has been achieved despite the broader adoption of ESG being complicated by the impact of quantitative easing (QE) on asset valuations. Central banks’ large scale purchases of bonds have not incorporated the same stringency on ESG factors, allowing some companies with less sustainable policies to achieve lower costs of financing, and heightening potential conflicts of interest between stakeholders. However, over the longer term, companies with a clear and credible approach to sustainability are more likely to be able to retain smooth and efficient access to funding.
Investors should question the available
investable universe, the nature and
breadth of any exclusions, and the
active management element of
The benefits of moving away from an index
The growth in ESG-themed investment has understandably led to the development of ESG-related indices. However, investors need to be mindful of the construction of these indices and the extent to which they are appropriately matched to their investment goals. For example, investors should question the available investable universe, the nature and breadth of any exclusions, and the active management element of any index.
Active asset management is well suited to sustainable financing, not only because of the level of potential engagement on ESG topics, but also because it means investors can use financing as a lever of change. An integrated ESG approach enables engagement with managers with the goal of influencing issuers to transition to an improved profile.
Identifying and engaging with
“turnaround” stories can be a key
generator of positive alpha in fixedincome
Identifying these potential “turnaround” stories can be a key generator of positive alpha in fixed-income portfolios. Passive strategies on the other hand may be constrained by their index allocations from buying certain bonds until their ESG rating has reached a certain threshold.
Meeting evolving investor demand
Public and private focus on sustainable investing is expected to continue to grow, so proactive issuers who can meet rising investor demands on disclosure and transparency should benefit. Proprietary research to identify material factors and areas for potential improvement will also be highly important. Thorough research will provide the bedrock for investors to be able to engage with company management and influence business practices, potentially unlocking value.
The integration of ESG is therefore equally as important in fixed-income investing as it is in equities. This is especially true given the growth in debt in recent years, which has helped sustain the equity growth story.
ESG is no longer a “nice-to-have” but an increasingly important and necessary cornerstone to any fixed-income investment strategy. Investors are more and more likely to expect asset owners to be accountable to the same ESG standards as those companies in which they invest.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional/professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP (Australian Registered Body Number 160 464 200) is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.
This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan]; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.