Crisis nips bond momentum but optimism holds

The push by Asia-Pacific asset owners and money managers to take environmental, social and governance considerations into account in managing their fixed-income investments will power ahead this year despite some COVID-19 speed bumps, market participants say.

The region's ESG momentum hasn't been able to entirely sidestep this year's coronavirus mayhem.

Money managers, who declined to be named, said one high-profile RFP they anticipated in May or June — an up to $2 billion ESG-focused fixed-income allocation by Taiwan's NT$4.2 trillion ($140.4 billion) Bureau of Labor Funds, Taipei — has been pushed back to the second half of the year.

A BLF spokeswoman said in an email the bureau's ESG fixed-income plans are "still under discussion."

Meanwhile, for the quarter ended March 31, global issuance of green bonds, dedicated to funding environmentally friendly projects, dropped 37% from the year-over-year quarter to $33.9 billion, as companies facing heightened uncertainty focused instead on issuing general purpose bonds to boost balance sheet liquidity, said Matthew Kuchtyak, a New York-based ESG analyst with Moody's Investors Service Inc.

In response, Moody's slashed its full-year forecast for green bond issuance to between $175 billion and $225 billion, from a February forecast of $300 billion.

Market participants predict such setbacks will prove fleeting in a region where growing numbers of regulators, asset owners and asset managers have embraced ESG investing in recent years.

Mr. Kuchtyak said another modest quarter for green bonds through June could partly be offset by record issuance of social bonds and sustainability bonds, a reflection of the "sense of interconnectedness" of environmental and social concerns inspired by the COVID-19 crisis. He said he sees no change to the strong five-year outlook for green bonds.

In the broader realm of ESG-focused fixed-income investing, meanwhile, "there's been a real explosion in interest among Asian clients," spawning increasingly sophisticated dialogues regarding how managers engage with corporate executives around sustainable development goals, said Jonathan Bailey, a New York-based managing director and head of ESG investment with Neuberger Berman LLC.

ESG considerations are having an ever-greater impact on the cost of capital for companies, leaving Asian corporates "increasingly receptive to having an ESG dialogue," noted Paul Lukaszewski, Singapore-based head of corporate debt for Asia and Australia with Aberdeen Standard Investments, as well as the firm's head of emerging market credit research.

Skeptics who saw interest in bringing fixed income under the ESG umbrella as a "late cycle, bull market trend" that would fade if economic conditions worsened are being proved wrong this year, said Mitch Reznick, Federated Hermes Inc.'s London-based head of research and sustainable fixed income, international.

A record $259 billion in green bonds was issued globally in 2019, up from $167 billion the year before and $44 billion five years ago, according to Moody's figures.

When it comes to requests for proposals being issued by asset owners, it's no longer a question of "are you" integrating ESG factors in bond portfolios but "how are you doing it?" Mr. Reznick said. Federated Hermes had $4.1 billion in ESG-integrated fixed income as of March 31, not including U.K. products.

On that front, while progress has been fastest in Australia, the "direction of travel" for other Asia-Pacific markets is the same — even if, for now, big sovereign wealth funds and national pension funds, such as Japan's ¥169 trillion ($1.58 trillion) Government Pension Investment Fund, continue to play an outsized role in extending ESG to fixed income, said Simon James, Melbourne-based Australian head of credit with investment consultant Willis Towers Watson PLC.

In its 2019 stewardship report released in late March, GPIF said it has begun to evaluate how all of its fixed-income managers are integrating ESG into their investment processes, and will conduct interviews this year on their approaches to engagement. The Tokyo-based giant, which invested ¥3.5 trillion in ESG-focused equity index funds more than a year ago, currently has no dedicated fixed-income ESG allocations.

Market participants say there's been a sea change in recent years when it comes to managers' views on their ability to engage with companies whose bonds they hold — in the absence of the general shareholders meetings and proxy votes that provide a platform for equity managers' ESG activities.

Bond managers are increasingly recognizing that a $60 trillion global fixed-income market where companies constantly issue new bonds or refinance maturing bonds gives them "a lot of opportunity" to engage with management, said Yoshie Phillips, Seattle-based director of investment research for global fixed income at Russell Investments.

Asset managers have come to accept that as providers of capital they can make a difference, agreed Jean De Kock, a Singapore-based senior fixed-income research manager with Mercer Investment Solutions (Singapore) Pte. Ltd. Increasingly, over the past year, "I hear credit analysts in Asia talking about specific conversations they're having with borrowers on ESG concerns," he added.

Engagement has come to signify "a change process" as opposed to a research process, said Yo Takatsuki, London-based head of ESG research and active ownership with AXA Investment Managers.

It's about "this is the way you're doing business — you have negative externalities causing harm to the wider environment or society and investors will be harmed if you don't resolve this issue," Mr. Takatsuki said.

The firm runs €508 billion ($569 billion) in ESG-integrated assets under management, or 63% of its total AUM, including €6 billion in green bonds across its fixed-income portfolios, as of Dec. 31.

The long-term nature of ESG-related risks adds to the importance of taking them into account even as it makes it tougher to gauge whether such efforts are paying off yet for clients, market participants say.

With a large segment of Amundi's more than €200 billion ($219.5 billion) of socially responsible fixed-income business invested with a "buy and maintain" to maturity approach, taking ESG factors into consideration allows for a broader analysis of the risk and opportunities that can weigh on credit quality — quite important for long-term investors, said Alban de Fay, Paris-based head of fixed income SRI and green bond strategies with Amundi.

That's key for an asset class with an asymmetric risk profile, where "you know what you can win but you can lose everything," Mr. de Fay said.

Still, investment consultants say it's too early to conclude that managers that have gone the furthest in developing models to gauge the impact of ESG risks on the pricing of bonds are garnering superior returns for their clients.

"ESG risks are long term in nature so it's hard to accurately attribute performance to superior ESG analysis," Mercer's Mr. De Kock said. Even so, Mercer believes "over (the) long term this analysis will help managers avoid downside," he said.

While engagement still isn't the first thing on the minds of asset owners looking to award ESG-focused fixed-income mandates, it's gaining in importance.

"Engagement is where the rubber meets the road," and clients are increasingly seeking "evidence that you're taking ESG into account in decision-making," said Travis Spence, a London-based managing director with J.P. Morgan Asset Management's global fixed income, currency and commodities group and head of the firm's EMEA investment specialist team.

Mr. Spence said JPMAM has moved methodically to integrate ESG considerations across the firm's entire fixed-income business over the past three years. At present, 100% of the firm's $580 billion in fixed-income AUM is ESG-integrated, up from roughly a third of its business three years ago, he said.

If the Asia-Pacific region remains "in its infancy" when it comes to integrating ESG factors in managing fixed income, markets there are working hard to climb up the learning curve rapidly, said Mahesh Jayakumar, Boston-based ESG fixed-income research analyst with MFS Investment Management.

It took Europe 25 years to stake out its ESG vanguard position but Asia could close the gap over the coming five years, AXA's Mr. Takatsuki predicted. By 2025, "highly sophisticated approaches" to ESG could become just a fact of life across Asia, he said.