Sustainable investing has become more important to all types
of investors in the past few years. And now, many in the retirement plan
industry expect plan sponsors will include more environmental, social and
governance (ESG) investments in their plans since the Department of Labor (DOL)
has issued a proposed rule that is more amenable to ESG investments in
retirement plans than regulations issued by the previous administration.
Much of the focus on ESG investing has been on equity
investments. However, defined benefit (DB) plan sponsors following a
liability-driven investing (LDI) strategy allocate heavily to fixed income, as
do defined contribution (DC) participants who are nearing retirement. Other DC
plan participants, even those in target-date funds (TDFs), also invest a
portion of their accounts in fixed income for diversification.
In a paper, “An Asset Owner’s Guide to Fixed-Income ESG
Integration,” Josh Palmer, head of fixed-income ESG research at Willis Towers
Watson in London, says one-third of all U.S. assets under professional
management now use sustainable investing in their strategies. He notes that
fixed-income ESG investments are already on the market, and the number of such
funds continues to rise.
He says plan sponsors can look at investment labels and how
they are marketed to find options, then do their due diligence to make sure
those choices are appropriate. They can also engage with managers that run
non-labeled ESG products with the aim of improving their ESG reporting. This
will enable them to see how they are integrating ESG factors, if at all.
Plan sponsors can find green bonds, corporate debt issued by
sustainable companies and debt with proceeds used for sustainable projects,
Palmer says. “The U.S. is one of biggest issuers of green debt,” he says.
“There is green infrastructure debt and green real estate debt—for example,
financing the construction of offices with a low carbon footprint.”
Palmer adds that green bonds are more common in DC plans
because these investments require lower management fees and are more liquid.
“There are labels on ESG fixed-income investments as there
are for ESG equity investments,” says Brendan McCarthy, head of defined
contribution investment-only (DCIO) at Nuveen. “For example, one of our
top-selling and top-performing ESG fixed-income investments is our Core Impact
The Willis Towers Watson paper notes that the “ESG
integration framework for fixed income has historically been opaque, either
overly reliant on an equity model or not specific enough on what ESG metrics
are relevant for bonds.” It says the diversity of the asset class, which
includes corporate bonds, sovereign bonds, securitized credit and private debt,
requires plan sponsors to take a nuanced approach to ESG investing.
The paper says asset owners’ questions for bond managers
Does the manager have a framework to assess ESG risks?;
How does the manager integrate ESG approaches to add alpha
(as exclusionary approaches could be limiting)?;
Similarly, does the manager create its own ESG ratings, or
use an external provider (which may be less robust)?;
Does the manager seek to benefit from lack of detailed ESG
coverage on specific issues/issuers (acknowledging this may be short-lived as
more managers expand capabilities)? Has this “ESG alpha” been isolated and are
there any examples to support this?;
Are there dedicated fixed-income corporate ESG resources? If
not, what overlap exists with equity ESG analysts and how are the gaps filled?;
Have all relevant fixed-income analysts and portfolio
managers received sufficient ESG training?
Looking at ESG Fixed-Income Investment Managers
“The way plan sponsors can find [ESG fixed-income
investments] is through sustainability-oriented manager due diligence,” Palmer
says. “That’s how we find sustainable investments in fixed income.”
Palmer explains that fixed-income managers might provide
reports with examples of how they’ve been investing sustainably, their
sustainability metrics and the average ESG score of their portfolios. In
addition, a manager might have separate sustainability targets—such as reducing
emissions over time—in creating allocations to investments with real-world
impacts. Managers also might have exclusions in place, he adds, and their
sustainability scorecards could include a positive screen strategy in addition
to excluding bad investments.
“We assess transparency, risk metrics and portfolio ESG
scores, as well as manager-level ESG scores,” Palmer says.
In addition, plan sponsors and their consultants can look at
“We look at engagement reports from managers, which provide
a summary of all engagements with issuers and other stakeholders,” Palmer says.
“That helps ensure a manager is an active investor and a good steward of
capital. It’s taking the extra step to make sure investments are being managed
Evaluating ESG Fixed-Income Investments for DC Plans
McCarthy says sustainability efforts can be as impactful, if
not more so, within fixed-income investments as they are within equity
investments. He says it is prudent for DC plan sponsors to look at ESG approaches
within fixed-income investments and how they can benefit and mitigate risk for
participants nearing or in retirement.
McCarthy suggests that, to identify the universe of
available fixed-income ESG investments, DC plan sponsors should enlist the help
of an investment consultant to ensure they can incorporate ESG benefits into
portfolios in a prudent way.
“ESG factors can improve performance and reduce risk,” he
says. “But it is important that the evaluation of ESG investments is done
properly, and a consultant can help.”
Unlike equity investments, finding successful fixed-income
investments is more about avoiding losers than picking winners, McCarthy
explains. So screening for ESG in fixed-income investments can help mitigate
downside risk by adding another assessment of business risk. “These areas of
risk are not often identified with traditional financial analysis,” he says.
McCarthy says the evaluation of fixed-income investments
should always start with investment performance. Even if they’re using an
investment consultant, plan sponsors need to understand an investment manager
or issuer’s process.
“Plan sponsors need to ensure they are looking under the
hood. Ask, ‘what does the investment mean by ESG or sustainable?’” he says.
“Sustainability is a subset within ESG that has two fronts: Environmental
relates to climate change, renewable energy, etc.; and social relates to community,
such as help providing affordable housing. And, as a fiduciary duty, plan
sponsors must assess strategies within an investment portfolio for pecuniary
McCarthy adds, “We will not sacrifice performance or distort
risk in pursuit of impact. It is important for plan sponsors to understand they
can invest sustainably in a responsible manner and still put investment
performance and risk management first.”
McCarthy says it is also key to understand the philosophy of
the investment manager and the pecuniary impact of that philosophy. “In light
of the DOL rule back and forth, plan sponsors can’t alleviate themselves from
focusing on good investments for the plan,” he says.
As with any other investment, McCarthy says, plan sponsors
should document the process for investment selection. In addition, for DC plan
sponsors, it is important to effectively communicate to employees about what
the product means. “ESG is more understood than it used to be, but there are
still some misunderstandings, so plan sponsors need to educate employees,” he
Palmer notes that greenwashing can be an issue. S&P
Global describes greenwashing as “making exaggerated or misleading
environmental claims, sometimes without offering significant environmental
benefits in return.” However, S&P says there’s little evidence of the
practice among sustainable investments.
Palmer says European officials are developing regulations to
protect investors from greenwashing. “If greenwashing becomes an issue in other
markets, we might see more regulations,” he says.
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