- Investment Director
United States, Institutional
Change
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As environmental, social, and governance (ESG) issues and sustainable investing continue to attract more attention from fixed income investors, we see a need to clarify what terms related to these pursuits signify about an investment strategy. Because ESG integration and sustainable investing styles factor into asset allocation decisions in different ways, clients seeking greater exposure to sustainable practices need to be sure that they are getting return profiles and portfolio characteristics consistent with their asset allocation objectives and broader organizational missions.
ESG integration
ESG integration is an element of an investment process, as opposed to an investment style. Integrating ESG is becoming part of the mainstream of fixed income investing to the point where considering it separate and distinct from prudent risk management is debatable. Many traditional fixed income investors incorporate ESG research into risk analysis because it gives them a more holistic picture of an investment’s long-term financial risk/return profile.
ESG data points can help investors identify material but difficult-to-measure risks and opportunities, including reputational, regulatory, or geopolitical risk, which can factor into investors’ assessment of securities’ “fair” valuations. For example, an issuer with poor governance practices could face legal or reputational risks in some global regions if modern slavery is discovered in its supply chain. On the other hand, an issuer with a robust climate transition plan could be poised to gain market share by adapting to changing regulations or consumer preferences more quickly than its peers.
Sustainable thematic investing
These types of strategies aim to meet financial return targets by investing in issuers whose management and operations reflect responsible stewardship of the ecosystems in which they operate. Sustainable thematic strategies may focus on sustainability generally, or on specific themes, including those related to climate change. Material factors considered in sustainable thematic investing could include an issuer’s positive impact on labor practices, financial inclusion, or carbon emissions and air quality. For sovereign issuers, these strategies may also focus on an issuer’s support for the rule of law and economic mobility.
Sustainable thematic investors see sustainability and stewardship as critical to the long-term financial health of both individual issuers and markets and economies in aggregate. This style of investing recognizes the value in looking beyond issuers’ short-term financial metrics to also consider how issuers take responsibility for the externalities of their day-to-day activities and the resulting long-term impact on public goods from which they benefit greatly over time, such as clean air and water, business/community relations, or trust in institutions.
Impact investing
Impact investing strategies seek to invest exclusively in issuers whose core goods and services make measurable contributions to solving specific social and environmental problems. Impact investors track issuers (and their strategy’s) progress on impact, in addition to progress toward a financial return target. Wellington’s fixed income impact approaches invest in issues and issuers aligned with 11 impact themes across three categories: life essentials, human empowerment, and the environment. Our impact investing team adds issuers to the universe of eligible investments based on its assessment of the materiality, additionality, and measurability of an issuer’s impact activity.
To sum up
ESG integration is typically part of how a fixed income investor analyzes potential risks and opportunities in order to optimize risk-adjusted financial performance. Sustainable investment strategies, such as sustainable thematic and impact investing, indicate what a manager invests in. Therefore, an allocator seeking closer investment alignment with a broader organizational mission or purpose may find a sustainable thematic or impact strategy most suitable. Conversely, an allocator aiming to increase exposure to traditional fixed income could benefit from understanding that ESG integration is merely a routine tool designed to enhance holistic consideration of an investment’s — or a portfolio’s — risks.
Our goal is to ensure that allocators gain the exposures they seek to meet their financial goals and overall organizational missions. We believe providing clarity and transparency on how we define and approach ESG integration and sustainable investing can help alleviate confusion and avoid misaligned asset allocation.
Go deeper
For a more in-depth discussion of the sustainable fixed income landscape, including both opportunities and challenges, please see Sustainable fixed income investing comes of age, co-authored by Investment Directors Anand Dharan and Meredith Joly and Fixed Income Trader Keenan Choy.
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