It’s been 12 years since the United Nations published its Principles for Responsible Investment (PRI) and, judging by the growth in signatories since 2006, the investment management industry largely accepts the benefits of integrating non-financial factors into investment processes.
There’s less consensus over what is meant by responsible investment – the term can mean different things to different people – and crucially over whether there’s a financial cost to it.
Such ambiguities have raised important questions for investors and issuers alike – even for those sold on the importance of what we now call environmental, social and governance (ESG) considerations.
If we’re to accept that ESG factors will play a permanent role in the investment process, they reasonably ask, how much importance should they be given, how should they be measured and by whom?
Crucially, they want to know, do ESG factors have an impact on borrowing costs and, if so, what are the implications for the fixed income market?
The PRI defines responsible investment as “an approach to investing that aims to incorporate ESG factors into investment decisions, to better manage risk and generate sustainable, long-term returns”.
The notion of sustainability was reinforced with the publication of the UN Sustainable Development Goals and was described by Ban Ki-Moon in 2015 as “ensuring prosperity and environmental protection without compromising the ability of future generations to meet their needs”.
In the absence of an official definition, the PRI’s fixed income investor guide suggests a key application for ESG information is to inform analysis of issuer creditworthiness, adding: “ESG issues, such as corruption or climate change, are potential risks to macro factors that may affect an issuer’s ability to repay its debt.”
The fundamental elements of issuer analysis remain the same for all types of issuers, it concludes.
An ESG factor is a non-financial measure that we consider may be likely to influence significantly an issuer’s ability and willingness to service its financial obligations. Crucially, we believe the assessment should be ours, but the measurement should not be.
A third-party measure means that clients are able, independently, to monitor the investment decisions made on their behalf.
Although there are many suppliers of ESG data and their definitions of ESG factors and interpretations differ, investment managers will increasingly incorporate the measures of one or more of these suppliers into their investment process.
Naturally, individual investment managers will weigh the significance of ESG factors differently from the third-party assessment and this will inform their views on the relative creditworthiness of an issuer.
However, they will incorporate other factors into their investment views, such as the currency, maturity, credit quality and sector of the bonds, as well as more traditional aspects of credit analysis such as the issuer’s corporate structure, business strategy and competitive position.
It’s reasonable to ask whether ESG factors have a distinct influence on bond prices.