Pensions see sustainability-related risks taking on greater importance
By Emily Holbrook
Environmental, social and governance (ESG) investing is spreading to all pockets of the fixed income markets. Recent findings from Bloomberg note that this includes sectors such as emerging market debt, which were until recently lagging in ESG data, tools, and insights.
The issuance of green bonds is a great example of this heightened interest in ESG from the fixed income sector. According to figures from the Environmental Finance Bond Database, total green, social, sustainability and sustainability-linked (GSSS) bond issuance crossed $600 billion in 2020 – nearly double the $326 billion issued in 2019. Furthermore, the Climate Bonds Initiative predicts that, even with a relatively modest growth rate, the annual issuance volume of green bonds could cross $1.27 trillion in 2023.
Fixed Income vs. Equity
Equity has been the dominant asset class when it comes to ESG integration; however, fixed income is becoming increasingly important as the information to support ESG tracking and analysis expands.
In contrast to equities, bond investors’ main ESG focus is on mitigating downside risk, rather than capturing upside potential. ESG metrics can help identify new risk factors, yet the diverse spectrum of debt instruments, issuers and maturities calls for targeted analysis in fixed income. Another difference is voting rights. Equities have obvious “ESG enabling” characteristics, such as the rights of shareholders to have their say on ESG via voting rights, while bondholders lack these ownership aspects.
Heightened Popularity of Sustainability in Fixed Income
BlackRock, the world’s largest asset manager, says the need for sustainable fixed income solutions is “pressing.” In the company’s research report, Sustainability: the bond that endures, BlackRock posits that “bonds are in high demand — against a backdrop of aging populations in search of yield, and geopolitical volatility that has sparked greater demand for ‘safe’ assets.”
Many large investors, such as insurers and pension funds, hold the bulk of their assets in bonds. Sustainability-related risks are likely to take on greater importance over the long horizons of such investors. Beyond these risks, there are specific issues that affect issuers and investors specific to their region. For example, the CFA Institute and Principles for Responsible Investing recently published ESG Integration in Canada, a detailed analysis of ESG on both the equities and fixed income sides. The report notes the three top issues regarding ESG in Canada:
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Environmental issues affect share prices and corporate bond yields/spreads more frequently than social issues; for sovereign debt yields, the opposite is true.
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ESG integration practices in Canada are more prevalent among equity practitioners than among fixed-income practitioners. Like equity practitioners, fixed income practitioners are predominantly performing ESG-integrated qualitative analysis of issuers.
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When analyzing ESG company disclosure scores, the social scores of companies are higher than their environmental scores across all sectors.
A Focus on Strategy
Samantha Hill
The Canada Pension Plan Investment Board (CPPIB), with more than $540 billion under management and more than 20 million contributors and beneficiaries, recently shared its ESG investment strategy with CAiP Forum.
“Our strategy is supported by a formal governance structure and a dedicated sustainable investing (SI) team,” said Samantha Hill, managing director of sustainable investing for CPPIB. “Our SI team works closely with investment and asset management teams on all major transactions across the organization to ensure an integrated approach to incorporating ESG considerations into our decision-making.”
CPPIB’s strategy includes the integration of ESG considerations through the life cycle of an investment – from due diligence, to ownership, to a portfolio company’s preparation for a public stock market listing. It also includes active ownership through direct or collaborative engagement with companies.
“We also expect our portfolio companies to disclose financially relevant, potentially material ESG factors,” Hill said. “We ask that companies explain why they have identified these risks, how they manage them, and how they have adjusted their performance and targets to improve them. We support issuers aligning ESG and climate reporting with the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD). A framework that focuses on numeric performance, rather than policy statements, is the most value-adding reporting mechanism for broad ESG metrics.”
Emily Holbrook serves as owner and head content creator at Red Label Writing LLC, a content studio that collaborates primarily with the insurance and financial services sectors.
