Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
How ESG is winning the bond market vote
by David Chaplin*
Fixed income managers are latching on to the environmental, social and governance (ESG) trend pioneered among their equity counterparts “with a sense of urgency”, a new Russell Investments paper argues.
The study authored by Russell global fixed income investment research director Yoshie Phillips, says over the last couple of years there has been a “rapid expansion” of bond managers adopting ESG practices after lagging share investors for some time.
Historically, those fixed income managers that have dabbled in ESG focused on integration into investment processes rather than engagement, given they lack the proxy voting tool available in equity markets: but that, too, is changing, the ‘ESG considerations in fixed income’ report says.
“The idea that investors can influence the activity of their holdings had a slower uptake among many bond investors, where ‘voting’ isn’t an option,” the Russell paper says. “Fixed income investment managers distanced themselves from the notion of engagement at first, while focusing more on integration. However, we have seen some indications that fixed income managers are finding their way into an engagement practice that leverages some of the unique features of fixed income investing in a more implicit manner.”
For example, fixed income managers that are part of diversified investment groups are teaming up with their equity corporate relations to exert ESG pressure on companies.
“And some bond managers who have limited or no equity offering try to partner with other bond managers to increase influence,” the report says.
Credit investors have taken up the ESG cudgel more easily than those in government bond markets – unsurprisingly, the paper says, “given corporate bonds are the closest to equities”.
“ESG considerations in corporate credit differ from sovereign bonds because the first is associated with companies while the second is associated with governments that become even more complex,” the Russell report says.
But as ESG terminology leaks into fixed income markets, bond managers face similar challenges to equity investors in sourcing reliable data and building consistent reporting standards.
The study says fixed income managers also differ in how they incorporate ESG analysts with some embedded among investment teams and others operating as stand-alone units.
“For the larger firms with separate ESG teams, we look for evidence that the separate team is influential in security selection and portfolio construction, while assuring that the importance of investment value is still the top consideration,” the report says. “For smaller firms adopting the integrated approach, the challenge is to demonstrate that the investment team is digesting those broader ESG considerations in an identifiable way.”
With ESG now at the “stage of universal recognition” among investors and asset owners, the study says fixed income managers must further develop how the theory works in practice.
“… standout approaches will be able to demonstrate leading implementation methodologies, articulate a best practice and define useful and informative metrics that are broadly recognised by investors as effective implementations of ESG considerations,” Russell says.
*David Chaplin is editor of Investment News NZ
