ESG survey: Spotlight on integration by fixed income managers

About the survey

When, what and why

Our annual ESG manager survey provides us with a deeper understanding of the ways that managers consider ESG factors, such as the levels of a firm's commitment and engagement, as well as investment policy implementations and the degree of ESG integration.  In 2016, 109 fixed income managers responded to our ESG survey. This year, we expanded the survey to include both equity and fixed income managers, and received 299 total money manager responses. The results serve as an important reference point for our manager researchers to engage in further dialogue at regular due diligence meetings.

For us, ESG integration is an important consideration we use when evaluating fixed income managers. We talk to many fixed income managers about ESG strategies and their approaches when it comes to ESG integration.

ESG consideration means different things to different people

One of the key points we've noted is that ESG consideration means different things to different people. To wit, there is no standard investment practice when it comes to ESG integration. Indeed, in our survey we've observed varying degrees and methods in regards to how fixed income managers integrate ESG factors into their investment practices. Below, we outline the three most typical ways that managers go about this:

1. ESG within risk management

In the past, the words ESG and Responsible Investing were primarily understood in terms of clients' ethical value judgements—and were often deemed as potential detriments to performance. However, an increasing number of the managers we surveyed have adapted their understanding of ESG and now see ESG factor assessment as an integral part of their risk management exercises. In our opinion, this makes sense, because capital appreciation opportunities are typically much more limited for bond investments than for stock investments—making downside management a crucial component of bond investing.

2. Integrating ESG data sets

One of the most prominent findings from our survey is that a large proportion of respondents have started to incorporate explicit ESG factors throughout their scoring methodology, while others have taken a more integrated approach. Some managers use their ESG scoring systems and data for companies or countries in which they invest. The ability to create independent ESG scoring methodologies and results has only become possible because of the increased availability of ESG-specific data for the fixed income market.

ESG data providers have seen tremendous growth in the fixed income market over the past couple of years. We found that a large number of our survey respondents use these newer ESG-related data sets to distinguish and separate inputs into their investment decisions, while others have made these ESG data sets an important part of their overall screening process (for the companies they invest in).

3. ESG as a governance consideration

ESG factors encompass a broad range of topics, such as climate change, sustainability, human capital employee health and safety, corporate governance and so on. The results of our ESG survey have highlighted how managers treat the governance aspects of ESG. We've found that the environmental and social factors are often considered as external risks, or non-financial considerations where their direct impacts are less clear. We believe this is partially because of the challenges in assessing the impact of these E and S factors on security prices, given that many E and S factors may show up episodically—often observed in negative events.

For instance, safety practices for workers often becomes a forefront issue only when there is an accident. Conversely, when companies manage the E and S factors well, the precise financial connection with a ESG consideration is hard to make. We see money managers increasingly incorporating these so-called non-financial considerations as a part of their security analysis, in order to obtain a more comprehensive view of the company or investment they're making. In other words, many money managers appear to be treating ESG considerations as risk management exercises in order to protect and enhance the economic value of the companies they invest in.

Effectiveness of ESG integration still in flux

The integration of ESG concerns into the portfolio construction process is more transparent for ESG-labeled strategies than for non-ESG labeled product offerings. To gauge the breadth, depth and nature of ESG integration in a provider's investment process, we ask several questions in our manager review process to understand the ways in which ESG considerations effect portfolio construction, including when ESG factors should dominate one's investment decisions outside of investment guideline considerations and whether any capital market research has been conducted. Our research shows that money managers are increasingly working to assess materiality of specific ESG considerations before making investment decisions. At the same time, we've observed that the increased ESG integration efforts occurring more broadly in the industry do not necessarily translate into improving ESG characteristics for non-ESG labeled strategies.

The wrap: ESG integration is an important component of any evaluation

While explicit ESG data is increasingly available for the fixed income market, the market still lacks a common practice in ESG integration. However, we believe that the ESG considerations made by a company or country do provide a more comprehensive picture of their risks. Companies or countries who are committed to improving societal outcomes through environmental, social and governance factors may find that their credit rating improves as well—which, in turn, produces positive economic value over time. Ultimately, we believe that understanding how money managers integrate ESG factors into their investment decisions is an important component to evaluating their security selection and portfolio construction processes.