For many investors, identifying financially material environmental, social and governance (ESG) factors is becoming increasingly important for everyday investment analysis – yet there are noticeable differences in practitioner uptake of ESG analysis between equities and fixed income.
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 a 2017 CFA Institute member survey, 76% of respondents said they used ESG analysis in listed equity selection. Fixed income came in second at 45%1. That’s somewhat of a wide gap, but one that seems to be narrowing. Equities have obvious ‘ESG enabling’ characteristics, mainly, the opportunity as shareholders to engage firm management directly and through voting rights. Bondholders, by definition, do not have these ownership mechanisms. However, given the sheer size of the debt market – which is considerably larger than the equities market – it makes sense that we’re seeing ESG integration and issuer engagement gaining prevalence in fixed income investing.
Stocks are known to be negatively and positively impacted by ESG news. Comparatively, debt pricing is less influenced by market sentiment in general. However, it is fixed income’s long-term time horizons that make it a natural candidate for ESG integration. Certain risks or opportunities require time to materialise. Through ESG integration, investors can attempt to identify externalities and company-determined factors that might become financially material over time. For example, further analysis of an issuing entity might reveal exposure to potentially material climate-related risks, such as coastal erosion or extreme weather events, which may not be apparent until many years down the road.
Multiple studies show a positive correlation between ESG factors and the ability of their issuers to meet their credit agreements. The illiquid nature of bonds may in fact make ESG analysis more important for fixed income than equities, as investors try to adequately hedge risk over time.
Increasingly, large institutional investors are seeking new sustainable investment opportunities and turning to fixed income as the next portion of their portfolios to focus on. Investment managers are responding to client demand with new ESG bond funds whilst many issuers are evaluating their strategies for sustainable business practices. The rapid expansion in the supply and demand for green bonds is a potential indicator of the exponential growth to come for ESG integration in fixed income. According to Bloomberg, green bond issuances were on target to reach $250 billion in 2018, a 60% increase from 2017.2
Though ESG integration seems to have gained interest among fixed income professionals, we are hearing from clients that there is still a way to go. Desire remains for a greater body of research and practitioner reference material to help train staff on how to identify ESG opportunity and risk when analysing fixed income. The information is much more readily available for equity analysis at this stage.
Investors are approaching ESG integration in diverse ways. As a servicer of assets, BNY Mellon is developing tools to support investor analysis. We have recently incorporated corporate fixed income data into our ESG Analytics capability, which allows institutional investors to score their equity and fixed income portfolios against ESG factors and other sustainability criteria. The capability gathers data on over 7,000 companies and 50,000 news sources across 20 languages to score companies based on ESG factors and the principles set out by the United Nations Global Compact Agreement. We see cross-industry collaboration as fundamental to laying the additional foundations needed to support investor interests and further maturity of ESG investment analysis.