Investors increasingly want their capital allocation to benefit from the opportunities that sustainability can bring, and to contribute positively to people and planet – ‘doing well by doing good’.
Global environmental and social megatrends, such as climate change and ageing demographics, are fundamentally shaping our future. As long-term investors, we are developing tailored investment solutions, which harness these trends, to gain exposure to companies playing a role in solving sustainability issues. By investing using a sustainability lens, to identify and invest in those businesses that are actively offering solutions, we believe this can help drive both future investment performance and facilitate the transition towards a more environmentally sustainable and socially responsible world.
Traditionally, equity-focused ESG funds have tended to dominate headlines and the market, however fixed income is catching up and becoming an important part of the product mix, in terms of the number of ESG solutions available as well as asset inflows, as evidenced by industry data such as those reported by Morningstar. Bond strategies are likely to play a critical role alongside other asset classes in driving the sustainability agenda, thanks to the size and diversity of the market – at some USD128 trillion in assets under management in 2023, the collective power of the fixed income investment universe is significant and notably larger than the global equity market, the latter being USD98 trillion.
Investing in the fixed income market opens up the opportunity set via the breadth of issuer types (e.g. opportunities to invest in sovereigns, for instance, as well as companies) and instruments (e.g. bonds with different funding structures and focused on different entities within a single company) available, while the investment risk-reward profile for some sustainability investments (e.g. not necessarily offering uncapped levels of returns) is particularly well suited to fixed income.
To date, when it comes to ESG, bond investors have typically been limited to either ‘pure’ impact investing (often associated with illiquid, private market investments), those focused on negative screen/exclusion-based approaches (where the bonds of issuers that don’t meet defined ESG criteria are removed from the investable universe), or those practising ESG integration, where the focus is on material ESG risks. However, filling and expanding the supply gap via liquid public debt markets and focusing on issuers and issuance, where the funds are contributing to solving specific environmental or social challenges from sustainability solutions providers, can offer fixed income investors the opportunity to align their portfolios with positive environmental and social outcomes, while also maintaining a focus on attractive returns and robust risk management.
The broader growth of dedicated ESG product offerings, especially the expansion of the fixed income asset class and dramatic growth of the ESG-labelled bond market, highlights the unique and critical role that fixed income plays in facilitating the global transition to a socially responsible, low carbon economy.
With the scale and urgency of the global environmental and social challenges we face today, contributing and demonstrating non-financial – as well as financial – outcomes from a fixed income portfolio may be a good option for many clients.