Fixed income investing can help target both financial and sustainability targets

Sponsored article: Adam Whiteley offers a guide to the ESG benefits of investing in fixed income.

Investing responsibly in fixed income can be crucial for local government pension funds looking to achieve either financial or sustainability objectives. The focus on ESG risks and sustainability factors could provide schemes with further opportunities to build portfolios that can target both financial and sustainability targets with greater precision, creating better outcomes for all stakeholders.

• ESG risks can define whether a debt issuer defaults;
• Fixed income investors have opportunities for frequent engagement;
• Bonds targeting specific environmental and social outcomes are now widely available;
• ESG risks are widely analysed for corporate debt, but less so for sovereign and other types of debt issuance.

Assessing debt issuers’ sustainability is vital for investors

The core focus for fixed income investors is the risk of an impairment to their coupons or return of principal. Any material risk that could affect whether an issuer fulfils these obligations— including environmental, social and governance (ESG) risks—will be relevant to investors’ analysis.

This is a central pillar of a responsible investment approach, and reflects a fixed income investors’ natural focus on the sustainability of an issuer’s operations and its ability to afford financial obligations.

For pension schemes with defined obligations, maximising the certainty of achieving this specific outcome is key. Investing with precision, including analysis of ESG risks to help ensure accurate valuations and effective risk management, is crucial.

Fixed income investors can have further-reaching influence than equity investors over governments and companies

Debt markets provide finance to a wide range of entities, including sovereigns, supranationals and agencies, as well as many companies, some of which prefer to raise finance using the debt rather than equity markets. This means that fixed income investors can have influence on entities and market sectors that are inaccessible to other investors.

Opportunities for dialogue are often regular. For many institutions access to finance from the bond market is an ongoing necessity, either to fund new projects or roll over existing debt. Fixed income investors’ influence can far outstrip that of equity investors; primarily due to a range of institutions dependent on debt capital markets for financing.

Collaborative initiatives—where investors work together to achieve a common goal—can have a meaningful impact. This power means fixed income markets can play a central role for investors seeking to influence governments and corporates, whether that is to achieve their financial or sustainability objectives.

Fixed income investors can pursue precise sustainability targets

In the now mainstream “use-of-proceeds” bond market, issuance can be linked directly to specific projects with a positive environmental and, or, social impact.

The most common are “green bonds”, where bond proceeds are used to support environmental projects. Investors’ ability to influence the terms and structure, mean fixed income assets offer the potential for meaningful influence.

It also means that, through the fixed income markets, investors are able to tailor their portfolios and objectives to reflect both financial and sustainability targets in new, innovative ways that are impossible using other financial instruments.

The scope of responsible investment activities in fixed income is set to expand further

ESG risks are widely analysed for corporate debt, but less so for sovereign, secured and other types of debt issuance. Much of this is down to the availability of good-quality data which is still more accessible at a corporate level.

More work is needed to develop ESG and sustainability data and research across fixed income markets.

The focus on ESG risks and sustainability factors could provide investors with further opportunities to build portfolios that can target both financial and sustainability targets with greater precision, creating better outcomes for all stakeholders.

Adam Whiteley is senior portfolio manager, Insight Investment.