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UBS Asset Management

PRI reporting framework 2019

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ESG incorporation in actively managed fixed income

Implementation processes

FI 01. Incorporation strategies applied

Indicate (1) Which ESG incorporation strategy and/or combination of strategies you apply to your actively managed fixed income investments; and (2) The proportion (+/- 5%) of your total actively managed fixed income investments each strategy applies to.
SSA
0 Screening alone
0 Thematic alone
0 Integration alone
40 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
60 No incorporation strategies applied
100%
Corporate (financial)
0 Screening alone
0 Thematic alone
0 Integration alone
100 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (non-financial)
0 Screening alone
0 Thematic alone
0 Integration alone
100 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Securitised
0 Screening alone
0 Thematic alone
0 Integration alone
40 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
60 No incorporation strategies applied
100%

01.2. Describe your reasons for choosing a particular ESG incorporation strategy and how combinations of strategies are used.

UBS AM sees the advantages of incorporating ESG considerations in fixed income as:

  • Providing a more holistic and comprehensive view on credit risk
  • Deepening the understanding of issuer quality, with a specific focus on the governance as well as environmental and social risks.
  • Increasing visibility that helps to confirm our views on credit risk, or identify trends or events that may lead to increased default risks and spread widening among certain issuers and in certain market environments.
  • An understanding of the dynamics of sustainability issues and trends that may lead to broader pressures on credit quality.

At UBS-AM we have taken the decision that ESG integration is strongest when the credit analysts sit at the heart of it. UBS-AM's fixed income team includes over 25 credit analysts with on average over 16 years of industry experience covering Investment Grade, Sovereigns, High Yield and Emerging Markets. This team is located in various centres including Chicago, Zurich, London, Singapore and Sydney.

01.3. Additional information [Optional].

UBS AM's ESG Integration efforts across our Fixed Income platform:

At UBS Asset Management our aim is to achieve the systematic integration of ESG into our proprietary credit research process. We believe that material ESG factors are best assessed as part of the company fundamental research process.

UBS AM's 25+ credit analysts provide research coverage for more than 1,600 issuers globally across fixed income sectors. The credit research process includes qualitative assessments of management strength, business strategy, market position, competitive environment, regulatory environment, and financial flexibility and quantitative assessments of historical operating results, calculation of various credit ratios and, most importantly, an expected future outlook. The analysts specialize in their sectors and build up valuable, in-depth knowledge over time to provide comprehensive credit review and analysis with emphasis on cash flow generation and sustainability.

We have integrated ESG considerations throughout our credit research process including investment grade and high yield credit assessments. This requires all credit recommendations by our Credit Research teams to address the most material sustainability strengths and weaknesses and also to assess the material impact of sustainability considerations on their credit recommendations and how sustainability risk factors influence their credit recommendation either positively or negatively. In order to quickly capture the outcomes of the credit analyst's ESG analysis, we have developed an internal ESG Credit Score. In addition, credit analysts will flag where their ESG analysis leads to a change in the credit opinion.

Implementation of ESG across the UBS AM fixed income platform is grounded on the collaboration between our credit analysts and our Sustainable and Impact Investing team. We have established protocols which guide how we address issuers which we cover, how to make use of external ESG ratings information, and how to address gaps in coverage. Our credit analysts are responsible for the ESG analysis of issuers within their coverage, supported by UBS AM's sustainability investment research team.. Through these dialogues, we are able to address questions about the materiality of an issue, the quality of an issuer's management of its risks, and how to balance different levels of materiality or the timing of how ESG issues are expected to develop. We use various data sources to gather information, including external ESG ratings providers, to inform our analysis of individual issuers and to help us with cross-sectoral and peer comparisons.

We view the value of our ESG analysis as deepening our understanding of the connection between issuers and the key sustainability trends that are material to their activities. To help with communication to portfolio managers, we encapsulate this in the UBS ESG Credit Score which comprises from 1 to 5 (best to worst). We supplement the UBS ESG Credit Scores with data from external rating providers for purposes of comparison within and across portfolios. We have also established approaches in which we reference the sustainability profile of issuers (and in some cases individual issues) in our consideration of sovereign, mortgage-backed/securitised, and municipal bonds investments.


FI 02. ESG issues and issuer research (Private)


FI 03. Processes to ensure analysis is robust

03.1. Indicate how you ensure that your ESG research process is robust:

03.2. Describe how your ESG information or analysis is shared among your investment team.

03.3. Additional information. [Optional]


(A) Implementation: Screening

FI 04. Types of screening applied

04.1. Indicate the type of screening you conduct.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
Negative/exclusionary screening
Positive/best-in-class screening
Norms-based screening

04.2. Describe your approach to screening for internally managed active fixed income

Negative Screening: We are able to incorporate negative screening lists for securities, issuers or certain sectors provided by clients into our investment process.

Positive/ Best-in class screening: We are able to tailor our investment management approach to accommodate SRI constraints within mandates directed by our clients. We also offer Sustainability focused strategies where investment guidelines include minimum and maximum limits with UBS-AM ESG scores.

Norms-based screening; We are also in the process of implementing a norms-based screening approach such that investments are screened based on whether or not they align with international standards and norms such as the UN Global Compact. For this we work with a selected service provider to develop a list of companies that are seen as breaching one or more of the principles. Cases are assessed by our sustainability specialists and, where necessary, we will initiate engagement to ensure that companies effectively close and remedy identified breaches and both communicate with stakeholders and ensure that they have addressed any management failures. Cases will be escalated for a discussion on exclusion when we consider that the engagement objectives have not been met.

04.3. Additional information. [Optional]


FI 05. Examples of ESG factors in screening process (Private)


FI 06. Screening - ensuring criteria are met

06.1. Indicate which systems your organisation has to ensure that fund screening criteria are not breached in fixed income investments.

Type of screening
Checks
Negative/exclusionary screening?
Positive/best-in-class screening
Norms-based screening

06.2. Additional information. [Optional]

We use the Sentinel system to monitor client mandates, product restrictions and regulatory requirements. Sentinel is a third party application used to automate guideline monitoring, and is used for pre- and post-trade monitoring. Accounts are monitored on a daily basis by a dedicated team who escalate any potential incidents to the portfolio manager, Client Servicing and Compliance teams.. The Sentinel Team sits within COO of UBS Asset Management so there is a segregation of duties between Sentinel and the investment areas. Any restriction changes are subject to sign off by a TRPA process and in some cases the Client Relationship Manager and Legal.


(C) Implementation: Integration

FI 10. Integration overview

10.1. Describe your approach to integrating ESG into traditional financial analysis.

At UBS-AM we believe that using Environmental, Social and Governance ("ESG") factors, or material, extra-financial data, in the investment analysis process improves the quality of the investment decisions. Incorporating these factors helps investors take a more comprehensive view of the potential risks of their investments.

Implementation of ESG integration across the UBS AM fixed income platform is grounded on the collaboration between our credit analysts and our Sustainable and Impact Investing team. We have established protocols which guide how we address issuers which we cover, how to make use of external ESG ratings information, and how to address gaps in coverage. Our credit analysts are responsible for the ESG analysis of issuers within their coverage, supported by UBS AM's sustainability investment research team. Through these dialogues, we are able to address questions about the materiality of an issue, the quality of an issuer's management of its risks, and how to balance different levels of materiality or the timing of how ESG issues are expected to develop. We use various data sources to gather information, including external ESG ratings providers, to inform our analysis of individual issuers and to help us with cross-sectoral and peer comparisons.

Moreover, our credit analyst recommendations are centrally stored and shared with portfolio managers globally, and analyst credit recommendations are discussed in regularly scheduled credit committee meetings, in which individual cases are discussed in a centralized manner with portfolio managers globally. ESG recommendations are included as part of the credit analysts' credit research and are also subject to the considerations of and discussions with Sustainable and Impact Investing team representatives.

By providing integrated recommendations that consider ESG risks and opportunities, UBS-AM avoids portfolio managers being forced to choose between the sustainability and the financial attractiveness of companies when making their stock selections, given that ESG considerations are taken into account in the research recommendations.

10.2. Describe how your ESG integration approach is adapted to each of the different types of fixed income you invest in.

SSA

The process of ESG integration, as described in our response to question FI 10.1 above, applies to all types of fixed income we invest in.

 

Corporate (financial)

The process of ESG integration, as described in our response to question FI 10.1 above, applies to all types of fixed income we invest in.

Corporate (non-financial)

The process of ESG integration, as described in our response to question FI 10.1 above, applies to all types of fixed income we invest in.

Securitised

The process of ESG integration, as described in our response to question FI 10.1 above, applies to all types of fixed income we invest in.

10.3. Additional information [OPTIONAL]

Applying ESG in fixed income is relatively new compared to the ESG approaches which have been developing in equities for some time. Some of the challenges that arise are:

Greater variability in the type of issuer:

  • Non-corporate issuers such as sovereigns, supranationals, agencies, securitized and municipals.
  • The presence of private issuers leading to more limited ESG disclosure

ESG data availability and quality:

  • Corporate data is incomplete especially in emerging markets and high yield
  • Sovereign ESG rating schemes tend toward high coverage but with tenuous connection to credit issues

The nature of fixed income instruments:

  • Different role of fixed income instruments in capital structures
  • Issues of duration and maturity of fixed income instruments
  • Bondholders rights compared to shareholders rights

UBS AM sees the advantages of applying ESG in fixed income as being:

  • Deepening the understanding of issuer quality, with a specific focus on the governance as well as environmental and social risks.
  • Increased visibility that helps to confirm our views on credit risk, or identify trends or events that may lead to increased default risks and spread widening among certain issuers and in certain market environments.
  • An understanding of the dynamics of sustainability issues and trends that may lead to broader pressures on credit quality.

UBS AM has described its view on integration of sustainability in fixed income in our white paper "The Next Frontier" published in June 2018. In developing our views, we have referred to the World Bank/GPIF paper "Incorporating ESG Factors into Fixed Income Investment", published March 2018.

While UBS AM sees advantages in integrating ESG consideration in fixed income we are currently cautious on the extent to which this improves the return of a portfolio. This is because of a very limited set of empirical studies that explore this connection. While there is now a large body of evidence pointing to ESG leading to neutral to slightly positive returns for equity portfolios[LK2] , the same depth of work is not currently available for fixed income. The principle point of reference is the Barclays paper "Sustainable investing and bond returns" published October 2016 which concluded that "a positive ESG tilt resulted in a small but steady performance advantage (and) no evidence of negative impact was found". Building on this study, Barclays' latest paper published in October 2018 finds that keeping all the other risk characteristics the same, a portfolio of high ESG bonds leads to higher performance. We are encouraged by these outcomes, as well as the examples that we are seeing from our ESG analysis work in credit research. However, until there is a broader range of empirical research pointing to ESG improving returns, we are likely to remain cautious about suggesting this as an outcome of ESG integration or factors.

Instead, UBS AM views the benefits of integrating ESG in our investment approaches in fixed income as providing an additional level of understanding taking into account that:

  • ESG scores at issuer level are useful but not enough. At UBS AM we are looking at the specific issues that connect to the investment case. Certain ESG topics are more material to the investment case at sector and issuer level.
  • The dynamics of sustainability suggest the potential for change. At UBS AM we seek to ensure a forward looking approach to the impact on credits. ESG analysis at the issuer level is stronger when it is forward looking, rather than based solely on scores and ratings.
  • The changing pace of sustainability challenges, as well as their potential scale, adds to the importance of understanding the key trends as well as what happens at issuer level.

FI 11. Integration - ESG information in investment processes

11.1. Indicate how ESG information is typically used as part of your investment process.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
ESG analysis is integrated into fundamental analysis
ESG analysis is used to adjust the internal credit assessments of issuers.
ESG analysis is used to adjust forecasted financials and future cash flow estimates.
ESG analysis impacts the ranking of an issuer relative to a chosen peer group.
An issuer's ESG bond spreads and its relative value versus its sector peers are analysed to find out if all risks are priced in.
The impact of ESG analysis on bonds of an issuer with different durations/maturities are analysed.
Sensitivity analysis and scenario analysis are applied to valuation models to compare the difference between base-case and ESG-integrated security valuation.
ESG analysis is integrated into portfolio weighting decisions.
Companies, sectors, countries and currency and monitored for changes in ESG exposure and for breaches of risk limits.
The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
Other, specify

11.2. Additional information [OPTIONAL]

Broadly speaking, UBS-AM pursues the integration of material sustainability factors into all analyst recommendations, which impacts all actively managed strategies. Through the integration of sustainability factors into the research process, the precise weight of sustainability across mainstream strategies will vary depending on the materiality and relevance of the sustainability issues for particular company cases. Fixed income and equity analysts assess material sustainability factors by considering the UBS proprietary score, as well as MSCI ESG Research reports. In addition, the Sustainable Investment Research and Engagement team has regular interaction with both fixed income and equity research teams to support materiality analysis of sustainability factors across various industries, as well as support on individual company cases.

Within fixed income, analyst recommendations are centrally stored and shared with portfolio managers globally, and analyst credit recommendations are discussed in regularly scheduled credit committee meetings, in which individual cases are discussed in a centralized manner with portfolio managers globally. ESG recommendations are included as part of the credit analysts' credit research and are also subject to the considerations of and discussions with Sustainable & Impact Investing team representatives.


FI 12. Integration - E,S and G issues reviewed

12.1. Indicate the extent to which ESG issues are reviewed in your integration process.

Environment
Social
Governance
SSA

Environmental

Social

Governance

Corporate (financial)

Environmental

Social

Governance

Corporate (non-financial)

Environmental

Social

Governance

Securitised

Environmental

Social

Governance

12.2. Please provide more detail on how you review E, S and/or G factors in your integration process.

SSA

We believe that fundamental, material ESG factors are best assessed as part of the company research process. These factors are fundamental in nature and need to be analysed as an integral part of the due diligence process.

Corporate (financial)

We believe that fundamental, material ESG factors are best assessed as part of the company research process. These factors are fundamental in nature and need to be analysed as an integral part of the due diligence process.

Corporate (non-financial)

We believe that fundamental, material ESG factors are best assessed as part of the company research process. These factors are fundamental in nature and need to be analysed as an integral part of the due diligence process.

Securitised

We believe that fundamental, material ESG factors are best assessed as part of the company research process. These factors are fundamental in nature and need to be analysed as an integral part of the due diligence process.

12.3. Additional information.[OPTIONAL]


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