Environmental, social and governance (ESG) investing has yet to prove itself as a long-term alpha-generator in global bond portfolios but it won’t hurt returns either, according to Adam Whiteley, fixed income portfolio manager with BNY Mellon subsidiary Insight Investment.
The London-based Whiteley, in NZ last week on a client tour, said some preliminary studies have shown ESG-filtered fixed income portfolios do outperform.
“We don’t believe ESG is a factor in underperformance but we’d need to see performance over a full market cycle before we can draw conclusions [about outperformance],” he said.
Whiteley said typical ESG strategies carve off about 20 per cent of the global bond universe without affecting portfolio construction techniques, diversification or returns.
He said Insight works with clients to design and implement ESG fixed income portfolios on a bespoke basis, which can involve negative screening, positive tilts or impact plays (for example, via ‘green’ bonds).
“The challenge is that ESG means different things to different people,” Whiteley said.
Part of Insight’s value proposition is to help clients define a responsible investment strategy before putting it into practice.
The firm itself has a long association with the responsible investing movement dating back to Insight’s 2002 launch year when it backed the-then Carbon Disclosure Project (now known as the Institutional Investors Group on Climate Change). Insight was also a foundation signatory to the UN Principles for Responsible Investment.
Whiteley said Insight has a dedicated responsible investment unit within the fixed income team to help tailor portfolios and assess ‘impact’ opportunities such as the growing green bond market.
But the sustainable label on fixed income offers needs serious scrutiny, he said, to combat ‘greenwashing’. Insight assesses the details of the green bond in question, including what proportion of the capital-raising is allocated to the targeted impact goal and how that goal measures up against the UN Sustainable Development Goals (SDGs) – the set of 17 global improvement principles set by the UN in 2015.
As well, he said the manager investigates the ESG credentials of the green bond-issuing company itself before approving it as investable.
In a recently-published report, Abdallah Nauphal, Insight chief, says responsible investment is “an essential part of managing risk”.
“We can all name companies that have suffered due to environmental, social and governance (ESG) issues,” Nauphal says. “For us at Insight, looking at such factors is part of considering all the relevant risks when making investment decisions.”
The Insight ‘Putting principles into practice: 2019 responsible investment report’, also lists the group’s analytical tools in the sector that include ESG questionnaires as well as climate change and sovereign debt sustainability indices. In its inaugural government bond sustainability report published last year, Insight rated NZ as the best-performing country of 186 as measured by ESG factors.
Whiteley said NZ is also one of the dwindling number of countries still offering positive yields in a world of falling interest rates.
“There’s something like NZ$20 trillion of government debt with negative yields in the world now,” he said. “Central banks are in a race to keep their currencies weak, driving a search for yield that is changing investor behaviour.”
Despite the distorted fixed income landscape, Whiteley said some good quality yield was still available but fixed income investors had to be more discerning.
Generally, fixed income investors seek yield by lengthening maturities, taking on more credit risk, going down the subordinated capital stack or leverage.
“All of these involve some degree of risk – each one slightly different,” he said.
Regardless, Whiteley said fixed income investors benefit from active management given the inherent risks in debt-denominated benchmarks.
“It doesn’t make a lot of sense to have more exposure to the most-indebted borrowers.”
However, he said a government bond benchmark, for instance, based on underlying country GDP rather than the scale of issued debt would be a more appropriate investable index.
A GDP-weighted sovereign bond index would be more aligned with the real global economy that reduces exposure to highly-indebted countries – such as the US or Japan – and redistribute it to lower-debt, higher yield jurisdictions like China and other emerging market nations, Whiteley said.
Insight manages about A$1.2 trillion globally, including A$25.6 billion from Australasia (where it has a Sydney office) with a single NZ client, Russell Investments, contributing about A$216 million to the pool.
The group specialises in fixed income but also offers multi-asset and currency management solutions to institutional and wholesale investors.