Environment, social and governance (ESG) investment is almost synonymous with investing in equities. This has resulted in the perception that equity investors alone deserve to be in the ESG ‘club’ due to their ability to influence company management teams through corporate engagement and the power of the shareholder vote. This perception, though, is incorrect. Fixed income investors have a fundamental role to play in sustainable investment.
The United Nations’ (UN) Sustainable Development Goals (SDGs) aim to help governments deliver social and environmental policy by 2030. Their ambitions - such as ‘no poverty’ and ‘affordable and clean energy’ - are huge.
The UN estimates that a massive US$ 2.5 - 3 trillion per year (UNCTAD World Investment Report, 2014) is required to achieve the SDGs in developing countries. Longer duration or fixed income funding are suited to tackling the goals due to their long-term nature. Governments around the world will be looking to both equity and fixed income investors to fill the funding gap.
Bonds are the most important source of corporate finance to help companies address themselves to the UN’s agenda. Debt markets regularly issue bonds with maturities in excess of ten years. The average holding period for an S&P 500 company, meanwhile, is four months. Furthermore, debt issuance is double the size of equity issuance.
In order to combat the scale of the problems posed by climate change, companies must make huge investments into their infrastructure. This is a classic long-duration investment.
Credit investors therefore have a significant opportunity to exert meaningful influence over issuers’ ESG risk management and disclosure.
Where state-owned enterprises sponsor infrastructure projects, fixed income investors could also exert influence, as these are likely to be financed through debt over equity. There is increasing awareness in markets that ESG issues can present material credit risk, for both sovereigns and corporates. Countries and companies with lower ESG scores have, on average, the widest spreads. Sustainability and governance issues affect a borrower’s ability to repay. Research has shown that companies with better governance typically have tighter credit spreads.
Ratings agencies also acknowledge this. ESG analysis is an established part of their evaluations. Moody’s has developed a heat map to illustrate how it sees environmental risks affecting different sectors. Standard & Poor’s (October 2015) believes environmental and climate risks “could lead to a more widespread weakening of corporate credit profiles, and subsequently more downgrades than in the past”. ESG has certainly arrived in the fixed income landscape.
Many hundreds of years of human behaviours have brought us here, to a place where our planet and societies face serious problems. If we are to unpick them, equity and fixed income investors both have a vital role to play.
Mona Shah is Head of Sustainable Investments at Stonehage Fleming. Read more articles from her here.
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