Ethical investing hits the mainstream
Ethical investing, once a niche category, is increasingly capturing mainstream capital flows.
Major disruptors, such as climate change and the COVID-19 pandemic, are fuelling a shift among investors in favour of more socially and environmentally responsible investment products.
It seems that environmental, social and governance (ESG) is coming of age.
ESG's time to shine
ESG Fixed Income aims to give investors all the benefits of fixed income while also achieving positive ESG outcomes. Over recent years we have seen a dramatic shift in activity: sustainable bond issues are more common, clients are more focused on company ESG performance and responsible investing is becoming more mainstream.
The urgent ESG challenge is how to transition the global economy to net-zero carbon emissions. This will require trillions of dollars of investment and could be a huge opportunity for investors, particularly in fixed income.
Equity options have dominated ESG investment in the past but global fixed income is a much larger market. Bond investors can have a powerful influence by engaging with issuers when they need to raise funds and pushing for sustainability commitments.
Also, unlike equity securities, which are issued in perpetuity, bonds have an expiry date. Once they mature, companies need to issue new bonds to raise capital, so investors have an ongoing influence and can help to drive positive change.
By collaborating with issuers willing to improve their ESG practices, investors can have a greater impact than by simply filtering out poor performers.
Our goal is not just to find the best opportunities for investors but to also create them by engaging with bond issuers. This way we drive change to provide the best opportunities to our clients.
Tackling climate change is an opportunity as well as a risk
PIMCO recognises that climate change will likely have a profound impact on the global economy. Rising global temperatures pose huge risks to communities and the ecosystems on which their livelihoods depend.
Limiting the physical damage and the financial toll is now a central policy goal for many nations, as well as companies. Increasing investment is being directed towards achieving net-zero carbon emissions.
The drive to net-zero carbon emissions is expected to increasingly influence the market pricing of all assets, not just those with a green tinge.
Regulation, carbon taxes and other public policies, as well as shifts in consumer sentiment and business models, will also affect market pricing.
The market for ESG bonds is already large and growing. According to Bloomberg New Energy Finance, as of 31 March 2021 there were US$1.5 trillion in outstanding bonds from a diverse set of issuers, including corporations, government and structured investment products.
We expect demand for ESG assets to increase.
Finding winners is tough
The transition to net-zero has created opportunities for fixed income investors, but it also increases the complexity of identifying winners. We are actively investing to address climate change in two ways:
- Dedicated climate-focused strategies.
- Climate-focused investments within our broader core dedicated-ESG strategies, such as our ESG Global Bond Fund.
PIMCO’s climate bond strategy is built and managed bond-by-bond because we believe active management and rigorous in-house analysis will help us spot the likely winners of the transition to net-zero.
We look for global leaders and innovators. We also leverage our broader ESG platform to help mitigate social and governance risks and develop a holistic approach to climate action.
When considering what to incorporate in our climate-focused ESG portfolios, we focus on three key segments:
- Green bonds are issued explicitly for environmental or climate-related projects. They may finance wind and solar energy projects or new methods for banks to support more environmentally sustainable business models.
- Un-labelled green bonds come from issuers who do not label their bonds "green" but whose businesses support the transition to a low-carbon economy. Examples include renewable energy ventures, like a solar company or a railway company.
- Bonds of climate leaders are issued by companies committed to mitigating carbon emissions and reducing their environmental footprint in areas such as water, plastic, air pollution or biodiversity. They find innovative ways to meet science-based targets and other emerging evidence-based standards. Examples include real estate investment trusts with clear and focused environmental strategies, and food companies committed to ending deforestation and sustainably sourcing their products.
We trust our own analysis
PIMCO does not rely on rating agencies or third-party researchers for ESG analysis. We do our own research.
We have developed several tools to help uncover opportunities and manage climate risk in investment portfolios. We have also created ESG scoring frameworks that are tailored to specific asset classes to help us avoid risks and capitalise on opportunities.
These tools allow portfolio managers to better mitigate climate-related credit risks and align with international commitments, such as the 2016 Paris Agreement targets.
Green bonds’ popularity is growing
Green bonds dominate this market, but social and sustainability bonds are gaining ground. We have seen an increase in COVID-19 related social bonds, for example.
Sustainability bonds are a growing segment but adoption has been slower. Most bonds have come from the corporate sector but municipal, agency and sovereign bonds are becoming more common recently.
ESG claims can be exaggerated. This is known as greenwashing. The best defence is to look past green labels to determine the true credentials of the issuer and the bond.
Green bonds need to fit PIMCO's credit selection and portfolio construction process. We consider valuation, top-down drivers (e.g., sector and regional selection, expectations on global growth and technical factors) and bottom-up drivers (e.g., credit strength, business model and covenants).
We assess bonds before and after they are issued. The result is the PIMCO green bond score, based on strategic fit, potential impact, red flags and reporting. The score helps us to select securities and allows for stronger differentiation among bond issuers.
Access to high-quality data has been one of the biggest challenges to ESG investing, but this is changing. PIMCO has been investing in the people and technology to incorporate these new data flows into our investment process, making it more precise and responsive.
My reading list
Bill Gates’ book, How to Avoid a Climate Disaster, is clear and well written. It not only covers the challenge we face, but also some of the opportunities that the fight against climate change will create, including for investors.
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Mr. Brons is an executive vice president in the Newport Beach office, specializing in global investment grade credit. He is a member of the ESG portfolio management team, focusing on credit. Prior to joining PIMCO in 2005, Mr. Brons worked at UBS...