packaged product. One of the areas where trustees need to be care- ful is when they use terms like “buy and hold” or “buy and main- tain” and make an investment in a bond expecting it to be like a gilt with attitude that produces an income over the next 10, 15 or 20 years.
If something is re-rated and shoots the lights out within the next five or 10 years, then they may not want to buy and hold. At a time when we are transferring risk from the pension regime to the insurance regime, I need to be fleet footed. So, liquidity is impor- tant to me. If I made all the profit I expected to make in a third of the time I was expected to make it, then I will bank it. Freedman: The responses we expect from issuers has changed. About 10 years ago you received a vaguely satisfactory response about the governance structure or the way they think about envi- ronmental hazards. There is much more scrutiny now on the qual- ity of the answers you are getting when it comes to ESG. In the meetings I sit in, the market is beginning to distinguish between issuers that are well prepared and answer questions on ESG strat- egy quite well, and those who are not.
O’Neill: That is an interesting point to link to bond managers. We rate managers and strategies on how well they demonstrate their integration of ESG factors. We have come across a couple of managers, predominantly located in the US, who have not been able to articulate that at all and have been surprised that the question has been raised. It has not just been us raising that question. Across Europe asset owners have placed it on their agenda, but there is a moving piece when it comes to the ability of a manager to articulate that as well as at company level. Gull: That is important. The external managers we employ take ESG seriously, but they are doing it differently and there are differ- ent levels of skills out there. There are managers who have focused on this for a long time and are probably slightly ahead of other managers and some of their understanding and articulation of the risks and the way to use it to construct portfolios intelligently. Nummela: We have been doing ratings for 10 years and what we have seen in the past five years is that the best ratings are for those who think about the opportunities and risks. They have increased from 5% to 10%. Great it’s doubled, but 90% are not working well with the aspects of risks and opportunities. That is happening in fixed income. In equities, the number is up from 10% to 20%. So fixed income is a little behind but there are still a fair few man- agers who are not thinking through this. From an owner’s per- spective, it is important to have the eyeball factor and to under- stand if there is a good process and is there a good team behind it.
PI: What we have heard in the past five minutes goes back to the education point. Is this training being led by the advisory side?
O’Neill: We help prepare clients seeing managers by helping them define what information they need. Something that often comes out when you ask for information is that you get a lot of it, but it is not necessarily decision useful. Deciding what the quality of infor- mation you need is, and distilling that down into a usable format, is critical for a client that has many other things to consider. Pickering: From a trustee perspective, advanced wake-up training is important. Then we can have just-in-time training when these asset classes become relevant and we can make decisions much more quickly in the light of that just-in-time training having had some generic wake-up training, perhaps on an annual training day when you are doing blue sky thinking rather than make your mind up time.
PI: How do you assess ESG in a government bond? Gull: That is a work in progress for us. It is hard to do. If you have a sterling bond portfolio, it is hard to manage that effectively with- out having the ability to go into gilts, maintain your duration and then come out if you happen to have a negative view on the US government, for example. O’Neill: Integration when it comes to sovereign debt has been focused on emerging markets. But if we take Australia, for exam- ple, you have an economy which is heavily reliant on natural resources. You have an economy which is susceptible to the out- come of climate change and what that means for the government in terms of raising revenue and fulfilling its social programmes. That is a developed market where it is possible to examine the physical and transitional-related risks that apply to that economy as a sovereign entity.
Emerging markets have been, in many ways, the focus of sover- eign debt integration, but it’s highly applicable to developed mar- kets as well. Freedman: We score each country by using public datasets and then overlay our proprietary analysis, which is especially impor- tant if circumstances have changed. There is a one to two-year lag, but we can see if things are improving or any changes that are being made.
In ESG there are many different factors within the sovereign mar- ket. Developed countries can allocate capital to the environment by improving flood defences or the energy mix. In some emerging markets, however, there is a debate between reducing emissions and feeding your people.
There are a lot of factors to consider. One is that it is harder to engage with sovereigns. The electorate is their most important stakeholder, but there are ways in through meeting other parts of the government. The size of the country and how much they rely on external capital influences the debate, but it’s not always easy to affect change. We score countries for our sustainable portfolios. We have a list of
February 2020 portfolio institutional roundtable: ESG and fixed income
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