Delivering impact type outcomes has been very much the preserve of equity funds up until now. However, times are changing, and fixed income is coming more into the impact mix. This is critical for driving the ESG agenda because ultimately to create longstanding and holistic change, fixed income plays a leading role. Not least because this market dwarfs that of equities, representing $128.3 trillion and $34.8 trillion in assets, respectively.
Active versus passive
For some time, ESG investing was limited to simply screening out the ‘bad bits’ of the investment universe. But any passive manager can do this, which begs the question – how can active managers add value within this space?
However, something that passive managers do not do is participate in engagement. With fixed income you have the chance to engage as a condition of ongoing issuance, through this there is the opportunity for ongoing dialogue. Meaning that, whilst bondholders do not have the voting rights of their shareholder peers, they do have the ability to support or withdraw support from new issuance – and hold the potential to drive up borrowing costs.
Layer on top of this active managers with the ability to go both long and short, and you have both the carrot and the stick at your disposal to push for positive change.
Shorting brown debt
One such case study is Saudi Arabia. A sovereign that has always been asset rich. Historically never needing to issue debt to raise funding. However, a couple of years ago, it came to a point where reserves had depleted on the back of lower oil prices, requiring them to tap capital markets.
At this time, our ESG proprietary framework identified Saudi Arabia as our highest risk ESG sovereign in terms of ESG rating. During early investor meetings we flew the flag of ESG, but – still in its infancy then – much of our feedback was dismissed. Soon after we took a sizable, active short position.
For the ensuing waves of issuance, Saudi was open to listening, wanted to engage, and ultimately wanted to learn what they could do to pursue a more progressive ESG agenda.
But shorting for the sake of ESG can be a Catch 22
Ironically, shorting for the sake of positive impact is something we are often limited in taking advantage of through our conventional funds only, versus our ESG-focused ones. The reason being that ESG focused investors tend to be more restrictive in their portfolio construction.
For example, most ESG focused investor would express the need for a blanket ban on tobacco. However, it’s an industry that we might like to short to push the ESG agenda forward. That said, we continue to see it as an approach where active managers can generate returns whilst offering the potential to drive positive change.
Looking ahead – buyer beware
According to some reports, ESG funds are projected to triple in size by 2025. Across the financial services industry, it’s become a bit of an ESG arms race.
As this market grows, so too will the need for investors to be able to identify those managers that greenwash or see ESG as a tick box exercise, versus those who are true champions for this agenda.
Within fixed income, green bonds are one such example of ‘buyer beware’. Whilst these securities certainly have a place, the waters are very muddied.
Perhaps a legitimate form of investment when the issuance of that debt leads a project to take place that otherwise never would have seen the light of day. Unfortunately, it feels like a lot of green bond issuance is simply being done by issuers looking to cash in on lower borrowing costs.
Instead, we see greater opportunity for positive change through fixed income via impact related bond strategies, where issuers are individually selected and there is the transparency available to measure the impact they are having. This should be further supported with the introduction of SFDR, with the regulator aiming to help investors easily identify instances of greenwashing.
