Sustainable investment assets globally reached US$40.5 trillion in 2020, according to latest available data. This estimated total value represents a doubling of the total amount over four years. Bond investors are actively participating in the growth of ESG investing through various approaches, including purchasing green, social and/or sustainable bonds, launching ESG funds, benchmarking against ESG indexes, and embedding ESG factors into the overall investment framework.
Of the primary ESG factors, governance is particularly important to bondholders due to the impact it can have on improving institutions and on the rule of law that supports economic development. From a bondholder’s view, the sovereign’s commitment to political stability and security, and the strength of the institutional framework that supports the financial sector, are strong indicators for improving creditworthiness. For corporate issuers, considerations that are particularly relevant include management incentives to ensure that their actions do not disadvantage bondholders in favor of stockholders; the structure of the board of directors; and the nature of the shareholding structure, among other factors.
Social issues and environmental factors, while still relevant and important, are somewhat more narrowly applicable compared to the governance factor. For a bondholder, the ability to influence social issues (e.g., worker rights, fair pay, and adequate living standards, etc.) is limited. However, where these social issues are inequitable, concerns about the stability of the country are raised, along with questions about the sovereign’s ability to service its debt. Environmental factors are crucial for sectors such as the extractive industries. From a credit perspective, the ability to effectively manage environmental risks (e.g., lapses and accidents) is a key concern as the company’s approach could have significant economic implications for the company, thereby affecting its debt servicing capabilities, as well as causing potential fatalities.
The increasing demand for fixed income ESG products has led to the development of tools for investors. Morningstar introduced their Sustainability Rating, which measures how well the holdings in a portfolio are performing on ESG factors, relative to a portfolio’s peer group. Fixed income ESG indices have also been developed to provide a comprehensive and efficient coverage of the investable universe. For the JP Morgan ESG index suite, weights are set by scalar as determined by ESG score. For fixed income asset managers, tools that aid in analysis of ESG factors and provide better transparency are critical in managing ESG strategies.
For investors seeking a more proactive EM ESG investment strategy, Stone Harbor offers an Enhanced ESG product for both EM Sovereign and Corporate investments.