Expanding ESG Coverage

Abstract

Whether the approach is dubbed sustainable investing, impact investing, or screening for environmental, social, and governance (ESG) practices, the trend of applying these approaches for investing has definitely gone mainstream. Until recently, the focus has been on equity investing, but the practice of applying ESG screens for fixed-income analysis is growing. According to the Global Sustainable Investment Alliance, the global sustainable investment market (including equity and fixed income) climbed to $21.4 trillion at the beginning of 2014, encompassing 30.2% of professionally managed assets in the regions of Europe, the US, Canada, Asia, Japan, Australasia, and Africa. The number is up 61% from $13.3 trillion at the start of 2012. The US, Canada, and Europe now account for nearly 99% of these sustainable investments, but growth has been trickling into the Asian markets of Malaysia, Hong Kong, South Korea, and Japan. In August, CFA Institute announced the results of a global survey of 1,325 CFA Institute members. The survey, conducted jointly with the Investor Responsibility Research Center Institute during May and June 2015, found that 73% of investment professionals worldwide consider ESG factors in their investment analysis and decisions, with 63% using it to manage risk. A significant 61% of respondents believe that companies should be required to annually disclose ESG sustainability indicators within the most up-to-date reporting framework, with 69% agreeing that disclosures should be independently verified and 44% supporting high-level audits. Although the survey didn’t distinguish equity from fixedincome securities, the findings reflect a broader movement that is changing the way investment managers look at ESG issues. “We’re seeing a cultural change as to how investment analysis is done,” says Matt Orsagh, CFA, CIPM, director of Capital Markets Policy at CFA Institute. “Investors are using ESG factors to build the whole mosaic needed to see the complete picture, going beyond the numbers and taking a holistic approach.” Approaches to ESG screening, both inclusionary and exclusionary, vary; however, more and more investment professionals are taking an integrated approach to ESG analysis across equity, fixed-income, and even private investment markets. “A comprehensive ESG screen helps to minimize excessive risk and allows us to find high-quality companies and securities,” says Samantha Palm, portfolio manager of the Parnassus Fixed Income Fund. “Securities that do well on ESG screens tend to be better-run companies. Companies that cut costs on safety, for example, typically have more accidents that impact a company.” Parnassus Investments, based in San Francisco, has built its reputation on deploying socially responsible screens and analysis across equity securities since its inception 31 years ago. In 1992, with the beginning of the Parnassus Fixed Income Fund, it adapted its approach for fixed-income sectors by incorporating corporate bonds and convertible bonds and, in 2013, commercial mortgagebacked securities and residential mortgage-backed securities. ESG screens are more narrowly defined, whereas socially responsible investing covers a wider swath, explains Palm. Not only does Parnassus use the same exclusionary screens for fixed-income securities that it uses for equities (e.g., nixing companies with ties to weapons, alcohol, tobacco, gambling, and direct investments in Sudan, with some minor allowances), but it also evaluates for positive performance attributes of environmental impacts, products, employee benefits and corporate culture, and corporate governance and business ethics. “We can apply ESG to either asset class,” she says. “The most important thing is to have a robust and repeatable process toward that end goal.” The trend has two main drivers: aging investors with diversified portfolios and enlightened investment managers, according to David Kathman, CFA, a senior analyst with Morningstar in Chicago. Although Morningstar hasn’t historically broken out ESG-screened fixed-income mutual funds, Kathman has been following several, some with rapidly growing assets under management. “Today there is much more of a focus on positive screening,” he says. Savvy managers “generally have a percentage of fixed-income securities that support renewable energy, community and economic development, plus green bonds to support green projects.” By year-end 2015, Morningstar will launch ESG scores for all of its 200,000 tracked global mutual funds and exchangetraded funds, to be based on each fund’s ESG footprint as determined by portfolio holdings. To develop its scoring system, Morningstar partnered with Amsterdam-based Sustainalytics, which provides ESG research and analysis and assigns companies 70 scores related to ESG policies and practices.