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joshua kendall

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How responsible fixed income investors play ‘central role’ in influencing governments and corporates

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By Joshua Kendall, head of Responsible Investment Research and Stewardship at Insight Investment.

Fixed income assets are the foundation of many investors’ portfolios and dominate global financial markets. The role of fixed income in institutional investor portfolios, and its dominance across global markets, means these assets cannot be ignored as investors seek to invest responsibly in pursuit of their goals.

Institutional asset owners with substantial liabilities, like pension funds and insurers, value fixed income as an asset class because of the contractually defined returns that fixed income instruments offer. Overall, investors are at the beginning rather than end of their journey with respect to integrating responsible investment into their fixed income portfolios. However, attention to ESG risks and sustainability factors can provide investors with further opportunities to build portfolios that can target both financial and sustainability targets with greater precision, creating better outcomes for all stakeholders.

When it comes to engagement, headlines typically focus on the power of shareholders who have voting powers that enable them to influence, and if necessary replace, company executives. However, the reality is that fixed income investors’ influence can far outstrip that of equity investors, primarily due to the range of institutions dependent on debt capital markets for financing. 

Debt markets provide finance to a wide range of entities, including sovereigns, supranationals and agencies, as well as many companies, some of which prefer to raise finance using the debt rather than equity markets. This means that fixed income investors can have influence on entities and market sectors that are inaccessible to other investors.

Opportunities for dialogue are often regular. For many institutions access to finance from the bond market is an ongoing necessity, either to fund new projects or roll over existing debt. This stands in contrast to the equity market, where issuance is comparatively rare.

While for major debt issuers, a single investor or asset manager can sometimes have little effect, collaborative initiatives – where investors work together to achieve a common goal – can have a meaningful impact. This power means fixed income markets can play a central role for investors seeking to influence governments and corporates, whether that is to achieve their financial or sustainability objectives.

When debt is issued, fixed income investors have the opportunity to influence the structure and terms of the issuance. A bond with unattractive terms could lead to financing on less favourable terms for an issuer. In rare cases, an issuer may withdraw an issue if there is not enough demand and sometimes change terms or documentation language to comply with investors’ requirements.

The regularity of debt issuance, combined with investors’ ability to influence the terms and structure, mean fixed income assets offer the potential for meaningful influence. The specificity that is possible to achieve also means investors can target sustainability outcomes in a way that other asset classes – such as equities – cannot offer.

In the now mainstream ‘use-of-proceeds’ bond market, issuance can be linked directly to specific projects with a positive environmental and/or social impact (the most common are ‘green bonds’, where bond proceeds are used to support environmental projects). Some bonds also build in targets at the broader institutional level, such that if sustainability targets are met, the issuer benefits from more attractive financing terms and similarly if targets are missed, the investor received compensation for this failure.

The growth of the impact bond market means that debt issuers across a wide range of markets and sectors, including sovereigns and private companies, are being encouraged to pursue explicit sustainability objectives.

It also means that, through the fixed income markets, investors are able to tailor their portfolios and objectives to reflect both financial and sustainability targets in new, innovative ways – that are impossible using other financial instruments.

Fixed income markets encompass a wide range of issuers and instrument types. While the basic principles of a responsible investment approach will remain consistent across them, the practical implications will be different. For example, most analysis of ESG and sustainability risks has focused on corporate debt, with research into their impact on sovereign debt still in a developmental phase. Much of this is down to the availability of good quality data which is still more accessible at a corporate level. 

Investing with precision, including analysis of ESG risks to help ensure accurate valuations and effective risk management, is crucial. The potential materiality of ESG risks is widely acknowledged. There are many examples of such risks having a material impact on the pricing of a bond, or leading issuers to default.

The Covid-19 pandemic highlighted the vulnerabilities of different sectors and industries, and demonstrated the importance of a sharp focus on ESG risks. The focus on governance also intensified after the collapse of German payments company Wirecard, where revelations of over-indebtedness and reported incidences of fraud led to significant losses for many investors.

There is no broad-brush approach to ESG analysis, nor consistent data to feed into a standardised rating or score. Different ESG data providers offer varying assessments, with inconsistencies, gaps and potentially misleading ratings. This led Insight to develop a proprietary model that aims to generate ratings that are more consistent and support our research.

To conclude, there is no doubt that institutional fixed income investors have an influential role to play in shaping the global responsible investment agenda. A responsible approach to investing in fixed income can also help achieve broader financial and sustainability objectives.

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