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Consideration of environmental, social, and governance (ESG) factors has increasingly come into the mainstream of investment conversations, both through routine incorporation into traditional investment processes and through distinct sustainable or impact styles of investing. Recent and current global conditions — including extreme weather events, the inequitable impacts of the COVID-19 pandemic, rising distrust of government institutions, and geopolitical challenges to a rules-based world order (such as the Russia/Ukraine conflict) — have accelerated this trend, highlighting the direct relevance of ESG and sustainability to understanding long-term market risks and opportunities.
Until recently, ESG and sustainability have been more of a focus for equity investors than for their fixed income counterparts. Encouragingly, that is beginning to change and doing so at a pretty swift clip too. Especially since the onset of COVID-19, ESG and sustainability have gained considerable traction among bond investors and, indeed, are now seen by many as integral to fixed income investing. For example, global sustainable debt issuance hit a new record high of over US$1.6 trillion in 2021 and is projected to keep climbing in future years (Figure 1). Notably, we believe that ESG integration and sustainable investing in fixed income necessitate a very deliberate, thoughtful approach — one that would vary meaningfully from one fixed income sector to another.
At a high level, we believe that increased awareness of ESG and sustainability provides two key benefits to global markets:
Like many others, we firmly believe that a stable global climate, clean air and water for all, adherence to rule of law, strong institutions with broad public legitimacy, and broad-based access to economic opportunity are valuable public goods from which market participants would collectively benefit over the long term. Therefore, a central objective of sustainable investing is to help markets in aggregate evolve toward rewarding participants for exercising responsible stewardship of these public goods that are so critical to pursuing favorable long-term outcomes for the real people who are markets’ ultimate beneficiaries. Framing sustainability in this way underscores why fixed income is so pivotal to moving global markets and economies in a more sustainable direction.
The size and heterogeneity of global fixed income markets presents both a compelling opportunity and a very real challenge for fixed income managers and investors who wish to prioritize sustainability and ESG.
As Figure 2 illustrates, the size of global fixed income markets makes them impossible to ignore in a conversation about ESG or sustainability. The diversity of these markets — spanning government bonds, corporate debt, and securitized assets from public as well as private issuers, and ranging from overnight to multi-decade maturity periods — means that virtually every facet of the global economy is somehow influenced by how fixed income markets function. Fixed income markets can impact real economic activity even more directly through the growing market for sustainability-linked bonds, whose performance may be linked to issuers’ deliverance on specific sustainable objectives deemed material to that issuer.
While the global fixed income markets are larger than the global equity markets, the growth of sustainable investing in fixed income space has lagged that of equities, even accounting for the growth of the sustainable bond market. As Figure 3 illustrates, assets under management (AUM) in active sustainable fixed income investment approaches still comprise a minority of total AUM in all active sustainable approaches. This suggests that there is a large untapped opportunity for such fixed income approaches to help effect more sustainable outcomes in global markets and economies.
The vital importance of fixed income markets to sustainability and ESG is the source of both the opportunity and the challenge for this type of investing. The opportunity is that if fixed income investment managers innovate and engage now on sustainable disclosures, market best practices, and product designs, their efforts can make an enormous difference in how quickly markets and economies shift in a more sustainable direction. The challenge? Fixed income managers will need to be adept at tailoring their investment approaches to sectors with vastly different characteristics and starting points in their ESG and sustainability “journeys.” We believe asset managers with breadth and scale in fixed income investing, along with depth of collaboration between their fixed income and equity and public and private spheres, will be best equipped to successfully navigate this challenge.
The ESG and sustainable investing styles that we recognize rely on many of the same inputs, including data and disclosures on material ESG metrics, agreement on which themes are material for the issuer’s business model or peer group, and issuers’ willingness to engage with investors on these themes. Investors can then use these common inputs to implement different approaches to ESG or sustainability, including: routine ESG integration; identification of leaders and “improvers” in adopting sustainable business practices; and determining if an issuer qualifies for an impact investing universe.
However, sourcing and applying these shared inputs is often easier said than done in fixed income. We believe this difficulty might be one reason why sustainable fixed income investment approaches have lagged their equity counterparts in recent asset growth and flows.
Across global fixed income markets, we have observed that investors face three fundamental challenges when seeking to deepen ESG integration and/or to develop sustainable investment strategies:
While these challenges are common to all fixed income sectors, managers need to adapt their approaches to ESG and sustainability sector by sector because each sector is in a different place on its respective “journey.” For example, some segments of corporate credit markets are quite mature in terms of investor activism, corporate awareness of ESG and sustainability, and data disclosures. By contrast, many securitized investors and issuers are still gaining basic familiarity with ESG and sustainability concepts and just beginning to define sustainable themes that are material to their sector (e.g., real estate climate risk, predatory lending).
For fixed income investors who wish to prioritize ESG integration or sustainability, we believe it is paramount to partner with an asset manager whose significant scale, global footprint, and breadth and depth of expertise — spanning fixed income and equities, public and private markets — can enable them to tailor their investment approaches to the unique realities of each fixed income sector. In our view, managers that can offer this type of tailored, sector-by-sector approach stand apart from the competition when it comes to:
Here are some examples of how we believe asset managers can differentiate their approaches by fixed income sector:
ESG integration and sustainable investing are no longer the exclusive domain of equity investors. Although assimilation and adoption of these investing styles have historically been slower in fixed income than in equities, investor demand for sustainable fixed income solutions has swelled in recent years, particularly since COVID first struck in early 2020. Accordingly, the pace of new product and instrument innovation is picking up.
Over the long term, fixed income could even play a larger role than equities in reorienting global markets and economies in more sustainable directions. In addition to fixed income markets’ size and the variety of ways that fixed income touches the real economy, the burgeoning market for sustainable bonds allows investors to directly finance sustainable projects or to hold issuers accountable for their progress on specific sustainability metrics. Thus, fixed income may offer a more direct path to investing in a sustainable manner.
We believe the future looks bright for ESG and sustainability in fixed income investing. In some corners of fixed income, such as private credit investing and direct lending, market participants are still barely scratching the surface, but we believe there is tremendous future potential. From our perspective, looking across the global fixed income spectrum, we have every reason to think the benefits of such investing to markets in aggregate will become more apparent in the years ahead.
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