Facilitator: Sam Shaw, independent consultant Expert: Paul Skinner, investment director – sustainable fixed income at Wellington
Headlines:
- A wide spectrum of sustainability and ESG exists across fixed income
- Scale and extensive research capabilities are essential to truly interrogate this space
- Inconsistency of data, methodology, research standards, and taxonomy make the sector particularly hard to navigate
- Regulation around this space is clunky, widely misunderstood and misinterpreted – e.g., disclosure regimes being used as a labelling framework
- A divide is emerging between ‘pure’ and ‘transitional’ ESG investments
Context:
A wide spectrum of sustainability and ESG exists across fixed income. From exclusion-based screening, to ESG integration, sustainable thematic, and impact investing, there is a range of approaches across fixed income, each at a different phase.
Gaps exists between client appetite, adviser understanding and competence, and the available solutions to enable them to make appropriate recommendations.
The same issues have applied in the equities space, but fixed income is lagging further behind.
Each of these approaches can have a role to play in an overall portfolio.
Scale and extensive research capabilities are essential to truly interrogate this space.
Looking across fixed income, the further away you move from conventional investment grade corporate credit, the more you must get under the bonnet and unpick the deal structure of each issue to understand the risks.
For gatekeepers, a fund group having scale and depth of resource in their research team is vital in order to do this.
Within sustainability, the pinnacle of this necessity is within impact: looking for a clear financial return, while knowing exactly where capital is being used, and measuring the outcome of that allocation.
Impact analysis must meet three criteria:
- Material: the majority of revenue must align with impact themes
- Additional: funding “new” impact, and not funding old projects that are >2 years old
- Measurable: impact must be quantifiable
Having a framework is important. In the corporate world, a fossil fuel-based energy conglomerate issuing a green bond will not be considered an impact investment (by Wellington). Although traditional government issuance will not, green sovereign bonds could meet the criteria if it’s possible to track the proceeds through their entire journey.
Inconsistency of data, methodology, research standards and taxonomy make the sector particularly hard to navigate.
Another of the biggest challenges – particularly in the impact space – is how to measure the outcome against the intention, with any sense of commonality.
There is a lack of standardisation across the industry: the regulatory position, taxonomy, and varying definitions all make it more difficult to point a client towards a particular solution.
The external credit ratings in ESG are notoriously unreliable and there is as yet no compulsion for any firm to release data on the various sustainability aspects investors may wish to see.
Data methodology, with its lack of transparency and consistency, is an easy element to criticise or blame. It prompts asset managers to create “unique” methodologies to sell as a USP, which is arguably in essence greenwashing. If each organisation is purporting a different way of doing things, it makes comparisons very difficult. Clients would benefit more from asset managers who were not fighting against each other and instead are working towards achieving unity.
Regulation around this space is clunky, widely misunderstood and misinterpreted
SFDR is forcing the hand of the asset management industry to position products at a certain point along the spectrum. Conflicts may arise between product marketers and fund managers. The UK’s Sustainability Disclosure Requirements (SDR) will include labelling and is expected to be far more beneficial to end clients.
SFDR has allowed for investment managers to put pressure on underlying companies to make progress or suffer disinvestment, forcing up their cost of capital.
The regulation however is somewhat clunky and the nomenclature can be unhelpful. But the direction of travel is where there is agreement – everyone wants to gain a clear understanding of funds’ sustainability characteristics.
One of the downfalls of SFDR has been the application of a numerical scale indicating superiority as you progress, i.e., Article 9 is considered ‘better’ (aka ‘greener’) by some than Article 8, which is not the case.
Similarly, creating a scale of regulatory disclosures suggests a scale down which returns get compromised the further along it you travel, which is also untrue.
A divide is emerging between ‘pure’ or ‘transitional’ ESG investments.
Asset managers and clients will often stand in one group or another –only investing in ‘positive’ companies and a purer opportunity set, or those that will invest in companies funding a transition. For example, investing in Shell issuing a green bond, in recognition that you can’t transform the world without energy companies being onside. It always comes down to a client’s individual preference.
For example, a credit sleeve for a large pension fund will be mandated to participate in the energy transition, which will require investing in oil, but only those meeting certain criteria, and focusing on engaging with them to push them along that journey.
Key takeaways:
- ESG is just one other element of the growing phenomenon of personalised investing and mass customization
- People want to invest in names and themes that resonate, reflecting their passions and interests. This makes for complex discussions with advisers. But it presents a challenge to the industry: how to blend impact analytics, thematic elements, return implications and expected volatility over time. How do you package that into a solution for the end investor?
- We must also be mindful of checklist-ticking, virtue signalling, and beginning to eliminate the investable universe
