Fixed-income investing can provide compelling opportunities for engagement with issuers on sustainability issues, improving outcomes for investors and the environment.
Last year, investor engagement triggered an important change in tack at a large US pharmaceuticals producer, leading to it making clear social commitments via access-to-medicines programmes. Investor engagement also brought pressure to bear on more than 50 US energy companies, urging them to set more aggressive targets for methane emissions abatement and to document their emissions abatement performance. The oil and gas industry is the second biggest source of methane emissions, which are the second largest cause of global warming according to the International Energy Agency (IEA).
At a time when investing along environmental, social and governance (ESG) lines in the world of equities has arguably moved from a quiet backwater to the mainstream, ESG-related engagement is often assumed to predominantly come from shareholder activism. But, in both cases, the pressure came from bondholders.
In the past year alone, ESG-related bond issuance totalled more than $1tn, which is equivalent to almost one third of the outstanding ESG bond universe, making it the fastest-growing segment of the global fixed-income market.
One of the reasons for this prolific growth is that investors are increasingly aware of the need to incorporate ESG factors across their entire portfolios, including fixed-income. “There are a number of ways investors have approached this, ranging from integrating ESG risks into the investment process to optimising for ESG metrics and including ESG bonds in their portfolio,” says Tina Adatia, Executive Vice President, Global Head of ESG Product Strategy at PIMCO, one of the largest investment-management firms.
Importantly, Adatia also highlights that fixed-income investing has a unique ability to influence a company’s sustainability journey and long-term ESG goals. There are two predominant reasons for this: first, in terms of size, the global bond market is larger than the global equity market and, secondly, new issuance dwarfs the issuance of shares1.
“Critically, as borrowers need to refinance their obligations, it provides fixed-income investors and asset managers a chance to engage with issuers on a recurring basis as these companies and governments come to the primary market to raise funds,” says Adatia. Often, issuers are also raising debt financing for specific capital expenditures and strategic initiatives, which creates additional scope to work with issuers to develop bond frameworks such as use of proceeds bonds (ESG bonds), which can align their financial obligations with their sustainability targets and drive transparency.
A bigger, more diverse market
Grover Burthey, Executive Vice President, Head of ESG Portfolio Management, argues that the increasing diversity of the ESG-related bond market provides a compelling lever for investors to align their ESG goals with financial performance across their entire portfolio.
Recent years have witnessed an explosion in the type of issuers looking to link debt with sustainability targets. Whereas only a few years ago, the ESG-related bond market was primarily dominated by utility companies and real-estate investment trusts (REITs), today’s market comprises issuers across retail, food and beverage, as well as other sectors of the economy. “It’s no longer just about the most carbon-intensive sectors,” says Burthey. “We are seeing a massive adoption of ESG-related debt issuance across the economy.”