Why is ESg investment on the increase?

According to the Global Sustainable Investment Alliance, over $22 trillion of assets were managed under responsible investment strategies globally in 2016, up 25% from two years before.

This is one of many statistics showing Environmental, Social and Governance (ESG) investing moving into the mainstream. We see 10 major trends contributing to the rise.

1. Good governance is systemically important

The financial crisis of 2008 was a wake-up call for public and private sectors, demonstrating how issues of culture and conduct could have systemic importance. Improving corporate governance is increasingly a goal for regulators and for fixed income and equity investors through active ownership.

2. Public-private partnerships are expanding

Public-private collaboration has grown from addressing infrastructure and housing needs to tackling broader social and environmental issues. The U.S. municipal market and the European agency market are two examples of how government vision has enabled private capital to drive social investments.

3. Climate change is a reality

Climate change is now universally understood and (almost) universally acknowledged. Mitigation techniques include international agreements such as the COP21 Paris agreement, which aims to keep the rise in world temperatures below two degrees, and private initiatives such as sustainable investment portfolios and more disclosure of climate-related financial risks.

4. Energy sources are shifting

Climate change aside, there is a transformation occurring in energy markets. Well-telegraphed supply and demand drivers are shifting the dynamics of the oil market, natural gas is now cheaper than coal, and renewable energy sources are becoming cheaper and scalable.

5. Technology is changing what we demand and how we consume

Whether it’s driverless cars in autos, smart metering in utilities, renewables in oil and gas, online sales in retail, or robo-advisers in asset management, most sectors of the economy are seeing paradigm shifts in the way business is conducted. Companies with ample resources and willingness to adapt will outperform, but others are likely to put investors at risk.

6. Social media is driving convergence in social norms

Given its borderless nature, social media has the potential to alter the cultural blueprint of countries, and for investors, its effects vary from changes in individual consumer preferences and traditional election patterns to subsequent demands for new regulations.

7. We are living longer

By 2050, there will be 2.3 billion people in the world over age 65, according to the United Nations. With average life expectancy rising in developed countries, sustainability issues will affect not only our children but also our older, less-capable selves. Climate change, income inequality, healthcare and poor governance are increasingly personal as they directly affect financial security in retirement.

8. Demographics are changing

Millennials and Generation-X are increasingly taking over from Baby Boomers in positions of influence, changing business, financial and political landscapes. The newly formed French government is an example – half of its members are women. Younger generations are driving the fast growth of the “green bond” market and the field of sustainable finance in general.

9. Regulation is providing tailwinds

ESG considerations have driven new regulations in a growing list of countries, which is tangibly affecting credit fundamentals. Examples include the shutdown of nuclear power in Germany, the Supervisory Review and Evaluation Process (SREP) in Europe, which governs subordinated financial debt, and France’s mandatory reporting of climate risk, which raises the bar for financial institutions.

10. Value chains are global

Large corporations’ value chains are increasingly global – as highlighted in our secular forum in May. These value chains are complex and if poorly managed can prove costly. Investors can be quick to punish companies for child labour practices, human rights issues, environmental impact and poor governance.

By Alex Struc, portfolio manager and Head of ESG Portfolio Management.

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Andrew Balls

PIMCO, a leading global investment management firm, has launched a dedicated Environmental, Social and Governance (ESG) investment platform globally, offering fixed income solutions to investors seeking attractive returns while making a positive social impact.

As part of this platform, the PIMCO ESG Global Bond Fund has been launched in Australia. The Fund, which marks PIMCO’s first dedicated ESG fund offered to Australian clients, has been launched to meet demand from clients looking to incorporate responsible and social considerations in fixed interest investing.

PIMCO’s unique ESG framework is underpinned by three key pillars: Exclusion, Evaluation and Engagement. The process not only excludes companies with business practices that are misaligned with sustainability principles, but also evaluates their ESG credentials and favours those with best-in-class ESG practices. Further, the team engages collaboratively with companies, encouraging them to improve their ESG practices and influence long term change.

The founding belief of this new strategy is that investors in ESG portfolios should not have to sacrifice their financial objectives in order to achieve an ESG impact.  The Fund aims not to compromise on investment returns to achieve social objectives by benchmarking itself against a traditional global bond benchmark, and invests in a range of sovereign and investment grade corporate bonds from around the world. The fund is managed by a team led by Andrew Balls, Managing Director and CIO of Global Fixed Income and Alex Struc, Portfolio Manager and head of ESG portfolio management at PIMCO.

PIMCO globally has also launched a dedicated ESG fund in Europe and the U.K, and enhanced two of its socially responsible funds in the U.S. to incorporate a wider range of ESG considerations into the investment process.

Andrew Balls, Managing Director and CIO of Global Fixed Income, said:  “For many investors, screening out undesirable investment categories isn’t enough anymore; they want to use their investments to promote change in the world. Our ESG Fund provides the tools to do that without compromising on returns.”

Alex Struc, Portfolio Manager and head of ESG portfolio management at PIMCO, said:  “Historically, this type of strategy has been pursued by equity investors but we firmly believe that engagement as a debtholder is equally important. Across the vast fixed income universe, small change can have an enormous positive impact.”

Adrian Stewart, Head of PIMCO Australia and New Zealand, said: “Sustainable investing is increasingly an important focus for many of our clients, yet there is a shortage of compelling ESG-oriented fixed income solutions available to investors. Having spent the last few years developing our processes and team, we are excited to invite Australian investors to participate in what we believe is an engagement-driven, industry-leading ESG platform. We think that PIMCO is in a great position to fill this leadership vacuum in this maturing market.”

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Kwame Anochie

Investors globally are becoming more engaged with the environmental, social and governance (ESG) factors that affect the well-being and smooth functioning of the global economy and markets.

The widespread endorsement of the United Nations Principles for Responsible Investing initiative, which has over 1,500 signatories from over 50 countries, is a key example.

Two primary drivers of this trend toward more sustainable investing are the changing demographic landscape and increased regulatory focus.

Demographics

Wealth managers globally are preparing for the great wealth transfer from the baby boomer generation to the millennial generation and female investors. Women are projected to control two-thirds of the world’s wealth by 2020 (according to MSCI’s issue brief, “2016 ESG Trends to Watch”), and millennials will increasingly become the world’s decision makers. Research also suggests that both millennials and women are increasingly looking to align their investment and financial goals with their values without diminishing their return expectations.

Regulation

On the regulatory front, one notable shift toward support for sustainability-focused investing was the recent change in U.S. Department of Labor (DOL) fiduciary duty rules allowing managers to incorporate ESG strategies. Fiduciary duty is the legal mandate to act in the client’s best interest when making investment decisions (e.g., focus on returns); the new DOL guidance acknowledges that ESG factors “may have a direct relationship to the economic and financial value of an investment.” Other regulatory decisions globally, including the ongoing European Commission work to develop non-binding guidelines for companies to disclose nonfinancial information and the Financial Stability Board’s task force to develop a voluntary standard on climate-related financial disclosures for companies, are all helping.

Evolution of ESG

The focus on ESG is wide-reaching. For example, the effects of climate change are now collectively acknowledged by governments, regulators, global corporations, asset owners, asset managers and the broader investment community. More investors recognize the urgency of understanding, stress-testing and hedging climate risks. Also, more people understand supply chain effects – the impact businesses have on their immediate and broader communities and potential costs associated with poor decisions. Culture and conduct are ever more important in how the financial system fulfills its mandate of facilitating sustainable economic growth.

Sustainable investing is no longer only a topic of a heated debate – we’re seeing new policy initiatives and regulatory changes underway. For example, 177 countries (including the U.S.) have adopted the climate agreement from last year’s COP21 conference in Paris. Under this agreement, governments and corporations will set targets that will trigger changes likely to affect the longevity of many different business models. As we discuss in greater depth in our recent Q&A, it is imperative that investors start early with identifying winners and diversifying away from losers. At PIMCO, we believe companies that position themselves for the transition should be able to deliver steady performance, while for those inflexible or unwilling to change, the costs may prove severe.

By Kwame Anochie and Alex Struc

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PIMCO Australia Pty Limited ABN 54 084 280 508, AFSL No. 246862 is located in at Level 19, 5 Martin Place, Sydney. Telephone number is 9279 1771. PIMCO Australia does not receive any remuneration, commission or other benefits for providing financial personal advice. Equity Trustees Limited ABN 46 004 031 298 AFSL 240975 (EQT) is the Responsible Entity and issuer of the PIMCO Australia Funds. PIMCO Australia does not charge any fees for the provision of general advice or other information concerning the PIMCO Funds nor does PIMCO Australia receive any commission from any third parties for the provision of general advice. However, if you invest in a PIMCO fund we recommend, we may receive benefits from the product issuer where permitted by law. As the investment manager of the PIMCO Funds, PIMCO Australia is entitled to an investment management fee and a fund administration fee for the relevant class of units in a PIMCO Fund. These fees form part of the management costs which are outlined in the relevant Product Disclosure Statement. This communication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. Investors should obtain a copy of the offer document in relation to any financial product mentioned in this communication before making an investment decision.

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