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In the Spotlight
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The COVID-19 pandemic has amplified investor focus on environmental, social and governance (ESG) risks. Our commitment to ESG remains resolute. We believe the GS ESG-Enhanced Global Income Bond Portfolio meets a deepening need within the investment world to achieve investment objectives with thoughtful consideration of ESG factors.
Jonathon: Like a traditional global fixed income portfolio, it seeks to access the broad opportunity set—corporate bonds, securitized credit and emerging market debt—to deliver high income and long-term capital appreciation. In addition, bonds held in the portfolio are identified through rigorous bottom-up fundamental research that integrates ESG analysis. An ‘ESG-Enhanced’ portfolio goes further by consciously promoting ESG characteristics.
How do we seek to achieve this? First, we implement sector and company exclusions based on established ESG standards1. This involves omitting sectors such as tobacco and bond issuers whose business models and actions are at odds with widely-accepted norms and values, including companies that violate the United Nations Global Compact principles. Second, we sharpen our ESG focus through analysis of a company’s revenue stream. This analysis is informed by social and environmental themes. For example, a Utility company would be excluded if more than a quarter of its revenue was derived from thermal coal generation; an activity that is one of the largest contributors to global carbon emissions and therefore a barrier to achieving the Paris Agreement2. Next, we further distil the investment universe based on our proprietary ESG scores, which Niamh will later discuss, eliminating bonds from the lowest scoring issuers3. Finally, we aim to target portfolio level ESG characteristics which are aligned to GSAM’s two primary ESG Themes: Accelerating the Climate Transition and Advancing Inclusive Growth.
In short, our GS ESG-Enhanced Global Income Bond Portfolio makes a conscious investment effort to avoid companies that—in our view—exhibit weak ESG profiles and target key sustainability themes at a portfolio level. We believe this approach is consistent with long-term performance potential.
Ashish: We believe ESG analysis is critical for identifying business risks in today’s markets and ESG integration is therefore our fiduciary duty as an active asset manager. Put simply, ESG is the responsibility of all investment professionals, not just those with ESG in their title.
Niamh: At GSAM, consideration of factors in the evaluation of creditworthiness has always involved assessment of risks that today we label as ESG, such as poor corporate governance and negative externalities arising from weak environmental or social practices.
Applying an ESG lens to our investment process can be powerful in helping to identify which ESG factors manifest into financial outcomes in each corporate sector or fixed income asset class – a concept known as ‘materiality’.
Active management is critical given ESG materiality is both fluid and sector specific and can include a time horizon element. Key events can also create inflection points. For example, the 2020 US election outcome presents new implications for sectors exposed to the energy transition.
Niamh: Our approach embodies three key sources of differentiation: materiality, momentum and bondholder engagement.
In 2020, we enhanced the robustness of our ESG toolkit by assigning proprietary ESG ratings to over 90% corporate and sovereign bonds under our research coverage. These ratings are determined by corporate sector analysts and sovereign economists, in consultation with dedicated ESG professionals, underlining Ashish’s earlier comment around the entire Fixed Income team being responsible for ESG.
These ratings are rooted in the concept of materiality and are established through a mosaic of analysis (Exhibit) rather than a single metric. Each bond issuer rating is comprised of a peer comparison (informed by external ESG data, proprietary fundamental research and bondholder engagement) and a forward-looking momentum assessment.
Source: GSAM. For illustrative purposes only.
Direct engagement with company management can help us cross-check ESG reporting with performance; this is crucial as disclosure alone does not imply good ESG outcomes. We also partner with our colleagues in the Fundamental Equity and Quantitative Investment Solutions teams on corporate engagements to enrich relationships with company management teams.
Engagement enables us to better understand a company’s strategy and qualitative factors that cannot be captured in ESG reporting. It also adds rigor to our momentum assessment so we can identify whether a company is on a stable, improving or deteriorating path. Again, this is something static ESG metrics can fail to capture.
Ashish: Uncertainty is a permanent feature of the investment landscape and our compass for navigating fixed income markets on behalf of our clients recognizes this. We seek to access and diversify across the broad fixed income opportunity set. We also look for openings to capture risk premiums created by market inefficiencies, and we see value in utilizing currencies and rates as a hedge for risk asset exposures. Last but by no means least, we advocate a sustained focus on ESG analysis which, as discussed, we believe is an important investment discipline that can uncover investment opportunities and help us manage downside risks.
In a data-driven and technology-oriented world, a continuous cycle of innovation can help us make smarter investment decisions faster, and with greater precision, to deliver better client outcomes. Key innovations in our fixed income platform in recent years include digitized research, proprietary investment signals and trading intelligence. These innovations enable us to be dynamic and flexible in our allocations to the broad global bond opportunity set.
Niamh: We cannot overstate the benefit of technology in identifying attractive investment opportunities that integrate ESG analysis. Our digitized research platform, Fluent, allows for seamless integration of external data and internal analysis. It also enables us to track engagement with company management. This technology is therefore valuable for both assigning and monitoring proprietary ESG scores. It further enables transparency for our investment process, which is crucial in meeting the investment reporting needs of our clients, including for ESG-Enhanced portfolios. Finally, it provides a holistic view of investment research which can be connected with portfolio construction applications that portfolio managers utilise daily.
Jonathon: Overall, our investment views are cautiously pro-cyclical. Improvements in activity have yet to move from forecast to fact, and so we think it would be premature to step back from pro-cyclical exposures, especially in light of continued central bank support. We continue to see opportunities in corporate credit, securitized credit sectors, and emerging market debt.
That said, we recognize that central bank policies support market conditions but do not prevent downgrade and default activity. We believe diversification, sector rotation and astute security selection—key tenants of active management—can help us manage both credit risks and identify opportunities for attractive income generation and capital appreciation. Furthermore, periods of strength and weakness can of course occur at varying times, emphasizing the importance of a dynamic and flexible allocation to the global bond universe, as Ashish noted.