Weekly View from the Desk
PGIM Fixed Income shares their weekly views and outlook for fixed income markets.
Bondholders are increasingly integrating environmental, social and governance (ESG) factors into their thinking and investment decisions. This requires a more nuanced approach than buying equities, due to the marketplace’s wide-ranging spectrum of debt instruments and loan terms.
At PGIM Fixed Income, ESG integration is the norm when building bond portfolios. Analysts take ESG factors into account as a matter of course when establishing credit ratings, credit-related risks and investment opportunities. Furthermore, because a country is not a business and a packaged loan is not an individual bond, they use specific ESG methodologies for each of the important bond categories—emerging market debt, government bonds, corporate bonds and securitised loans such as asset-backed securities and collateralised loan obligations.
While ESG analysis is now standard procedure at PGIM Fixed Income, the team go even further when evaluating bond opportunities, to strive for impact. The business views ESG investing through two lenses. The first is financial materiality: How do ESG factors influence a bond’s risk and return? The second is impact: Does the bond issuer have a positive or negative impact on society and the environment?
Combining the two lenses can be complicated, as financial materiality, ESG analysis and impact don’t always coexist easily, explains Unanyants-Jackson. She cites the pharmaceutical industry as an example. Patents give drug companies exclusive rights to make and sell medicines for extended periods, which accords them substantial pricing power. When they issue bonds, this power is positive in terms of credit risk because it increases the likelihood a company will be able to pay the coupon (i.e., annual interest rate) and that investors will be able to redeem the bonds at the end of their terms. However, if this power causes medicines to be unaffordable to the masses, it lowers the issuer’s positive impact on society.
Unanyants-Jackson points out that a reverse scenario is also possible and cites the auto industry and its powerful trade unions as an example. The unions can collectively bargain for favourable contracts, which is a positive outcome for their members. Yet the greater this bargaining power, the higher the potential credit risk for the industry’s bonds.
However, financial materiality and social impact don’t always clash. High-quality products with proven safety records have a positive impact on both consumers and on the credit of the product manufacturers issuing bonds.
‘These examples clarify why we need to carefully evaluate investment opportunities through both lenses,’ Unanyants-Jackson says.
The PGIM Global Total Return ESG Bond strategy, the sustainable component of PGIM’s $58.4 billion Total Return Bond strategy1, considers both a bond’s return and the issuer’s impact on society and the environment. Based on fundamental, sustainability and impact criteria, investments are made worldwide in a diversified bond portfolio. Under the supervision of PGIM Fixed Income’s ESG committee, a team of more than 110 analysts1 assigns ESG impact ratings to each potential investment to determine whether it is suitable for inclusion in the portfolio.
Unanyants-Jackson clarifies the evaluation process using a corporate bond as an example. First, the team analyse the issuer’s sector and whether its characteristics produce a positive or negative impact (e.g., carbon dioxide emissions in the oil and gas sector or employee rights in the garment industry). ESG data providers offer further information that the team use to gain insight into these impacts. Some impacts relate to an issuer’s products and services, and others to its operations. When analysing factors that are harder to quantify, the team talk to industry leaders and collect data directly from companies without ESG ratings. This process allows the team to develop an ESG impact rating for each investment candidate.
‘It’s about achieving a qualitative rating informed by data,’ says Unanyants-Jackson. ‘For ESG strategies, we will not purchase debt securities from issuers with an ESG impact rating below a certain threshold.’
Equity investors appear to have an advantage over fixed income investors when it comes to ESG investing and its impact. Unlike stockholders, bondholders traditionally have had little influence over the companies in which they invest. That notion is changing. ESG factors help improve credit analysis, and PGIM Fixed Income engages with bond issuers to properly understand these factors, as well as the investment opportunities and risks involved.
‘The deeper we delve into ESG, the more interaction with issuers is required to help us go beyond risk and return considerations,’ says Unanyants-Jackson. ‘Some very interesting talks take place with issuers, as some have not yet given any thought to their impact on society and the environment.’
PGIM is the global investment management business of Prudential Financial, Inc., with more than $1.5 trillion in assets under management as of 30 September 2021. More than half of this total—$964 billion—is managed by PGIM Fixed Income.
1Source: PGIM Fixed Income as of September 30, 2021.
For Professional Investors only. All investments involve risk, including the possible loss of capital.
Past performance is no guarantee of future results. The views expressed herein are those of PGIM Fixed Income’s investment professionals as of 25 November 2021, may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Any projections or forecasts presented herein are subject to change. This commentary does not purport to provide any legal, tax or accounting advice. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice.
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