ESG investors side with equities over bonds

But bond managers argue the approach is integral to identifying downside risks

UK institutional investors overwhelmingly prefer equities to fixed income for applying an environmental, social and governance (ESG) approach, despite the fact the strategy can be important for limiting downside risks.

No UK investors thought ESG was more material for fixed income strategies, whereas 43.3% argued it was more material for equities.

However, ethical bond managers argue the asset class has a strong case for applying ESG analysis due to its asymmetrical risk-return profile.

RobecoSAM Global SDG Credits strategy manager Jan Willem de Moor says ESG is integral to identifying downside risks. “We are not looking for very large potential upside, which you might do as an equity investor. Our main concern is always not to lose money as a bond investor and it helps to look at ESG factors in creating a better investment opinion about particular companies.”

UK lags on fixed income ESG views

Overall, the majority (53.3%) of UK investors thought ESG was equally important to both asset classes. The UK was the only region where no respondents thought fixed income could more effectively employ ESG than equities.

Only 3.3% of UK respondents thought ESG wasn’t important at all. However, in Europe no investors agreed with the statement. In contrast, more than a quarter (25.2%) of US respondents thought ESG wasn’t important to equities or fixed income.

Source: RBC Global Asset Management

The UK was the region most likely to argue there aren’t enough fixed income products that incorporate ESG factors with 65.5% agreeing this is the case compared to the global averaged of 43%.

Source: RBC Global Asset Management

Fixed income ESG funds

My-Linh Ngo (pictured), head of ESG investment risk at fixed income specialist Bluebay, said that most fixed income products that were tagged as ESG were mostly investment grade bonds and green bond funds, but there was an increasing interest in high yield, emerging market debt and sovereign bonds.

Looking at FE Analytics data, there are only 17 fixed interest funds that have an ethical or sustainable focus. The £460m Kames Ethical Corporate Bond fund is the oldest, launching in April 2000, while the £1.2bn Rathbones Ethical Bond fund, launched two years later, is the largest.

Investment Association fixed interest funds with an ethical or sustainability focus

Axa – World Funds Global Green Bonds
EdenTree – Amity Short Dated Bond
EdenTree – Amity Sterling Bond
Epworth – Affirmative Corporate Bond
Epworth – Affirmative Fixed Interest
F&C – Responsible Sterling Bond
Kames – Ethical Corporate Bond
Liontrust – Sustainable Future Corporate Bond
M&G – (Lux) Global High Yield ESG Bond
Newton – Newton Sustainable Sterling Bond
Rathbone – Ethical Bond
Royal London – Ethical Bond
Royal London – Investment Grade Short Dated Credit
Royal London – Sustainable Managed Income Trust
Sarasin – Responsible Corporate Bond
Standard Life Investments – Ethical Corporate Bond
Threadneedle – UK Social Bond
Source: FE Analytics

Across Luxembourg and Irish-domiciled products there are 141 fixed income funds that were classified as “socially conscious”.

Material ESG risks particularly relevant to fixed income

Robeco’s fixed interest teams began applying an ESG approach in 2010. “We not only look at the balance sheet or the strategy of the company, we also identify ESG risks or opportunities,” says Willem de Moor. The team also invests in green bonds where the credit quality of issuer is sound.

The Liontrust Sustainable Future funds apply the same screening process to both equity and fixed income strategies. “The equity guys are obviously looking for more growth and trying to capture the upside in companies that are seen to be doing better things for society and the environment,” says bond manager Aitken Ross.

“On the fixed income side, we’re looking for stability so companies that are generating stable returns. We believe sustainability and stability of returns are a great fit for fixed income investors.” The risk-return profile is asymmetrical, Ross says, so while there might just be 5% of upside, bond managers want to minimise the downside risk that an issuer defaults.

Volkswagen, EDF and Deutsche Bank are all bonds that have suffered volatility due to ESG risks but that the team has avoided due to their investment process, he adds.

Ngo tells Portfolio Adviser‘s sister publication Expert Investor there were characteristics that certain ESG strategies would play out better for emerging market debt versus developed markets, certain strategies would work better for sovereigns versus corporates, or high yield versus investment grade.

“You’ll also see a lot more differentiation of product offering in the near future,” Ngo says.

Bondholder engagement on ESG

In terms of ESG engagement, Ngo says that selectors needed to recognise that it was possible for bondholders to engage with companies and even governments but not to the same extent as shareholders.

“The ability to engage and get companies to change their practices in the high yield market may be more challenging than if you’re investing in a company that is investment grade,” she says.

“Investment grade companies tend to be larger, better resourced, so they are more able to respond to investor enquiries and expectations.”

Robeco bond and equity teams work together to engage with companies, says Willem de Moor. “It is easier as an equity investor to engage with companies than for bondholders. If there is an engagement case, we have a dedicated engagement team, but they will also always involve the equity analysts and also the credit analysts to gather their opinions.”

Sovereigns present a unique ESG problem

On the sovereign side, Ngo says sovereign analysts did meet with government representatives and officials but it was more challenging than dealing with companies.

“Fundamentally you have to recognise that the government in place has not been elected by investors they’ve been elected by the people,” she says.

“When you engage with corporates it’s more straightforward, and you might see change within a year or two, but when you’re engaging on long-term labour or social reforms with a country, it’s not necessarily going to come through in six months or a year – it’s going to take a longer time frame. So you’ve got to have a lot more patience.”

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