How Asset Owners Can Integrate ESG into Fixed Income

Greater data in the asset class will go a long way, says a Willis Towers Watson report.

Allocators integrating environmental, social, and governance (ESG) considerations into their equity portfolios should determine how they can do the same in their fixed-income allocations, say consultants at Willis Towers Watson. 

It’s far from an easy task for investors, who are dealing with a dearth of data for fixed-income instruments—corporate bonds, sovereign bonds, securitized credit, and private credit investments—that is far behind what is already accessible for public equities, researchers said in a Willis report released Monday. 

For asset owners, that means they should start assessing how thoughtfully asset managers are evaluating sustainability in their fixed-income investments, according to Nimisha Srivastava, global head of credit at the firm. Instead of relying solely on third-party ESG ratings companies, investors should use them as starting points to judge assets. 

“If that’s your starting point, they need to build on that and have their own ratings on bonds based on their knowledge of what the company is doing or where it’s headed,” she said. 

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Corporate credit investments are the most straightforward assets to integrate into ESG strategies, the report stated, given that they are similar to public equities and are less opaque instruments. Investors measuring ESG in corporate bonds should remember to evaluate whether firms will outperform in the future, Willis contended. 

Green bonds have also grown in popularity, but the study warned that there should be better monitoring of the assets so that they can be better assessed by managers.  

Securitized credit is among the weakest fixed-income instruments when it comes to ESG integration within portfolios, Srivastava said. For example, asset managers in collateralized loan obligations (CLOs) might not have enough data to see which loans score highly on sustainability, and which do not. 

A pool of 100 bank loans may hold two firms that are weak sustainability investments, so investors can decide to divest of the CLO entirely, or decide whether the return profile compensates those ESG risks. For Srivastava, it’s most important that asset managers drill down for more granular data, so investors can start measuring their exposure. 

On the other hand, private credit managers are leading the way when it comes to thinking about sustainability considerations, thanks to longer investment horizons that are spurring some innovation in the asset class, Srivastava said. 

The consulting firm itself has invested in a couple different renewable investment strategies. On the private credit side, Willis seeded a team working on renewable infrastructure debt strategies, a niche investment the firm is expecting a healthy premium from. In securitized credit, the firm has invested in solar asset-backed securities (ABS) to tap into a market where consumers are making energy improvements to their homes. 

“We think managers that are being creative about finding these new spaces are kind of well placed to succeed over the long term, because these are both areas that I think in five years’ time will just become mainstream. But today, they’re quite niche and narrow,” Srivastava said. 

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