Report: Fixed Income ESG Can Improve Risk Management, Returns

Report touts benefits of incorporating ethical investing into fixed income.

A growing body of research suggests that incorporating environmental, social, and governance (ESG) factors into fixed income investing can not only strengthen risk management, but should also contribute to more stable financial returns, according to a report from the World Bank and Japan’s Government Pension Investment Fund (GPIF).

 The report said that based on its research, incorporating ESG doesn’t means having to sacrifice good returns. It found that roughly 90% of studies show a nonnegative relation between ESG and corporate financial performance, and highlighted a Barclays study that found that a high ESG rating results in a small but steady performance advantage.  Additionally, the report cited financial services firm Allianz as saying that investment-grade bond issuers with material ESG risks and persistently low ESG scores are to be avoided, and that an exclusion filter leads to no significant performance impairment.

“ESG investing is increasingly becoming part of the mainstream investment process for fixed-income investors,” said the report. ‘Traditionally, the main focus of ESG investing has been on equity markets. In recent years, however, ESG has spread out increasingly to other asset classes, in particular fixed income, given that bonds constitute a substantial percentage of institutional investors’ assets.”

The report focuses on the private sector, and makes recommendations to support the broadening of ESG investing across fixed-income asset portfolios. Some of the recommendations include promoting more robust research on the impact of ESG factors on fixed income investment, refining principles and metrics to allow for customized approaches by investors, and developing products to accommodate the growing demand for fixed-income sustainable investments.

“Our research collaboration with the World Bank Group will help encourage greater awareness and wider adoption of ESG integration in fixed income,” Hiro Mizuno, CIO of GPIF, said in a release.

The report’s findings combine existing research, results of interviews with more than 30 major investors, ESG data providers, and rating agencies, as well as feedback from a workshop convened by World Bank Group and GPIF.  It found that investors are increasingly combining ESG and impact considerations, such as measuring the impact of their fixed income and other portfolios on targeted ESG outcomes.

However, “despite this positive trend, significant constraints limit the wider adoption of ESG considerations in fixed-income markets,” said The World Bank, adding that there are no standard definitions of ESG, and data “is still wanting,” particularly in emerging markets.

“There are additional issues,” said the World Bank, “such as how to pursue engagement with fixed income vs. equity issuers, particularly sovereigns; the role ESG plays in credit ratings and indices; and a lack of ESG-focused products for fixed-income investors.”

The report is part of a wider collaboration between the World Bank Group and GPIF to promote strategies for including ESG criteria in investment decisions across different asset classes.

“This sends a strong signal to other investors,” said World Bank Group President Jim Yong Kim, “that this is a smart way to earn a higher return, ensure that developing countries have the sustainable resources they need, and help end poverty.”

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