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Wellington Management Company LLP

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You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income » (C) Implementation: Integration

(C) Implementation: Integration

FI 10. Integration overview

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

Wellington Management considers environmental, social, and corporate governance (ESG) criteria as one set of factors among many that should be weighed appropriately to inform investment decision making. To help our portfolio managers and investment teams better assess risks and opportunities in client portfolios, Wellington has integrated the analysis of ESG factors into our investment and risk-management processes firmwide. To aid in the integration of ESG analysis, our specialized in-house ESG team manages several investor tools, including an innovative portfolio review process, ESG ratings, and reference guides that examine ESG factors by sector and country. Our ESG team also works closely with our portfolio managers and analysts to engage with company managements each year.

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

SSA

For government bond portfolios, we have resources available to help investors assess the ESG risks or opportunities that would impact the long-term economic growth and sustainable development of the respective countries. For example, ESG issues relative to sovereign bonds can include political stability, corruption, social inequality, investment in education, and climate change management.

In addition, portfolio managers may develop their own custom approach to ESG integration. For example, we employ a proprietary country scoring model in our Emerging Markets Debt approach that enables us to quantify the sovereign credit outlook for the 60 emerging market countries that we cover and rank them according to their credit strength from high to low. The primary aim of the model is to provide greater rigor to our country research and to highlight potential vulnerabilities in individual countries. The resulting score for each country is adjusted to reflect important qualitative factors such as political stability, which then facilitates cross-country comparisons. The country scoring model is one element of the research process, and as such the Portfolio Manager does not have to override the output of the model.

The scoring process begins with a top-down quantitative assessment of macroeconomic and debt sustainability conditions using a proprietary model that assigns a numerical score to each emerging markets country. The specific inputs and their weights in the model are proprietary, but they include what we have determined to be the key drivers of credit spreads, such as a country's economic performance and debt burden, the government's fiscal position, and the country's quality of governance. Overall, the model employs 10 factors that we found to be the most valuable in determining the credit strength of individual countries.

In emerging markets, however, quantitative measures alone cannot tell the whole story. Rather, the quantitative component of the analysis ensures that every country is reviewed with the same disciplined framework. Our team of experienced sovereign analysts then adapts the raw quantitative score to reflect those less quantifiable factors that may have a meaningful impact on credit spreads, such as political risk, central bank independence, and structural reform progress. Usually, the quantitative and fundamental credit scores are similar, however, in some cases; the politics are such that the final score is meaningfully different than the raw credit score, reflecting a greater credit risk than the numbers alone might imply.

The core of the country scoring model has remained consistent since the inception of our emerging markets debt approach in 1999. We do recalibrate the model every few years, however, in order to refine the specific factors and improve the effectiveness of the model.

Historically, research has focused on a sovereign’s ability to pay its debts. However, ability to pay is no longer the only consideration for investors; they also need to gauge the willingness of sovereigns to make their bond payments. We use a number of factors to gauge the ability and willingness of governments to pay their debts. Inputs include contingent liabilities of the state or metrics such as total debt to exports or revenue to debt, among others. However, the issue of willingness to pay necessitates the inclusion of politics into one’s risk assessments, as it can be a major factor in determining how bond markets will behave.

To assess willingness to pay, we consider the World Bank’s Government Effectiveness index in our bond rating analysis. Research shows that sovereigns with strong governance scores tend to be awarded high credit ratings, while countries regarded as having corruption problems tend to have lower credit ratings.

Inputs that can be used to assess the ability to pay include financial and economic ratios as the ones mentioned above. However, to assess the ability to pay, we also look at social factors, such as the World Bank’s Ease of Doing Business index, which indicates how well the regulatory framework in a country supports the setting up and running of businesses. The more-business friendly a country is, the higher tends to be the credit rating. A business-friendly environment is also consistent with higher tax revenues for the state that positively affect the ability to pay.

Corporate (financial)

Our approach to corporates taps into the issuer research conducted by our central ESG Research team.
We provide central ESG integration resources to portfolio teams firm-wide, and we approach ESG integration as a tailored process that can be applied to all asset classes. We do this by analyzing ESG risks and opportunities in our clients' portfolios, engaging with companies in which we invest to discuss material ESG issues, and voting proxies on our clients' behalf to support decisions that we believe will maximize the long-term value of securities. Wellington Management's culture is built to support collaboration and our open-architecture "community of investors" naturally lends itself to the integration of ESG considerations.

Our ESG Research team, part of the central Investment Research function, helps our portfolio managers and analysts gather deeper intelligence on ESG topics and integrate these considerations into the investment process. We believe that a holistic understanding of how companies deploy capital - financial, physical, and human - is helpful in framing an investment thesis, and examining ESG issues gives us a more complete picture. Our ESG analysts are responsible for conducting in-depth analysis of the ESG factors most relevant to the sectors within their coverage area. They are also responsible for coordinating the ESG engagement strategies for the companies in their sectors with equity and fixed income analysts and portfolio managers. Our ESG team works closely with investment teams to incorporate our research into the investment process - regularly conducting in-depth portfolio reviews with investment teams to discuss holdings with the greatest ESG risks and strengths.

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security, as well as within our proxy voting and company engagement efforts.

Corporate (non-financial)

Our approach to corporates taps into the issuer research conducted by our central ESG Research team.
We provide central ESG integration resources to portfolio teams firm-wide, and we approach ESG integration as a tailored process that can be applied to all asset classes. We do this by analyzing ESG risks and opportunities in our clients' portfolios, engaging with companies in which we invest to discuss material ESG issues, and voting proxies on our clients' behalf to support decisions that we believe will maximize the long-term value of securities. Wellington Management's culture is built to support collaboration and our open-architecture "community of investors" naturally lends itself to the integration of ESG considerations.

Our ESG Research team, part of the central Investment Research function, helps our portfolio managers and analysts gather deeper intelligence on ESG topics and integrate these considerations into the investment process. We believe that a holistic understanding of how companies deploy capital - financial, physical, and human - is helpful in framing an investment thesis, and examining ESG issues gives us a more complete picture. Our ESG analysts are responsible for conducting in-depth analysis of the ESG factors most relevant to the sectors within their coverage area. They are also responsible for coordinating the ESG engagement strategies for the companies in their sectors with equity and fixed income analysts and portfolio managers. Our ESG team works closely with investment teams to incorporate our research into the investment process - regularly conducting in-depth portfolio reviews with investment teams to discuss holdings with the greatest ESG risks and strengths.

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security, as well as within our proxy voting and company engagement efforts.

Securitised

Our approach to securitised debt taps into the issuer research conducted by our central ESG Research team.
We provide central ESG integration resources to portfolio teams firm-wide, and we approach ESG integration as a tailored process that can be applied to all asset classes. We do this by analyzing ESG risks and opportunities in our clients' portfolios, engaging with companies in which we invest to discuss material ESG issues, and voting proxies on our clients' behalf to support decisions that we believe will maximize the long-term value of securities. Wellington Management's culture is built to support collaboration and our open-architecture "community of investors" naturally lends itself to the integration of ESG considerations. During 2017, the ESG team hired an experienced analyst from Wellington's municipal credit analysis team, which has greatly increased the team's focus on fixed income and securitized assets specifically. 

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security, as well as within our proxy voting and company engagement efforts.

In our assessment of securitized issuers, in particular mortgages and commercial mortgages, we pay particular attention to physical climate related risks given the nature of these fixed assets. 

10.3. Additional information [OPTIONAL]


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 in Additional Information

11.2. Additional information [OPTIONAL]

The application of ESG by credit analysts varies by sector, as each analyst has their own philosophy and process that informs recommendations.


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

For government bond portfolios, we have resources available to help investors assess the ESG risks or opportunities that would impact the long-term economic growth and sustainable development of the respective countries. For example, ESG issues relative to sovereign bonds can include political stability, corruption, social inequality, investment in education, and climate change management. 

In addition, portfolio managers may develop their own custom approach to ESG integration. For example, we employ a proprietary country scoring model in our Emerging Markets Debt approach that enables us to quantify the sovereign credit outlook for the 60 emerging market countries that we cover and rank them according to their credit strength from high to low. The primary aim of the model is to provide greater rigor to our country research and to highlight potential vulnerabilities in individual countries. The resulting score for each country is adjusted to reflect important qualitative factors such as political stability, which then facilitates cross-country comparisons. The country scoring model is one element of the research process, and as such the Portfolio Manager does not have to override the output of the model.

We employ a proprietary country scoring model that enables us to quantify the sovereign credit outlook for the 60 emerging market countries that we cover and rank them according to their credit strength from high to low. The primary aim of the model is to provide greater rigor to our country research and to highlight potential vulnerabilities in individual countries. The resulting score for each country is adjusted to reflect important qualitative factors such as political stability, which then facilitates cross-country comparisons. The country scoring model is one element of the research process, and as such the Portfolio Manager does not have to override the output of the model.

The scoring process begins with a top-down quantitative assessment of macroeconomic and debt sustainability conditions using a proprietary model that assigns a numerical score to each emerging markets country. The specific inputs and their weights in the model are proprietary, but they include what we have determined to be the key drivers of credit spreads, such as a country’s economic performance and debt burden, the government’s fiscal position, and the country's quality of governance. Overall, the model employs 10 factors that we found to be the most valuable in determining the credit strength of individual countries.

In emerging markets, however, quantitative measures alone cannot tell the whole story. Rather, the quantitative component of the analysis ensures that every country is reviewed with the same disciplined framework. Our team of experienced sovereign analysts then adapts the raw quantitative score to reflect those less quantifiable factors that may have a meaningful impact on credit spreads, such as political risk, central bank independence, and structural reform progress. Usually, the quantitative and fundamental credit scores are similar, however, in some cases; the politics are such that the final score is meaningfully different than the raw credit score, reflecting a greater credit risk than the numbers alone might imply.

The core of the country scoring model has remained consistent since the inception of our emerging markets debt approach in 1999. We do recalibrate the model every few years, however, in order to refine the specific factors and improve the effectiveness of the model.

There has been particular interest and involvement from the Emerging Markets Debt team in the physical climate risk research being conducted with Woods Hole Research Center (WHRC). Given that the sovereign market is geographically concentrated by nature, there is strong alignment in the geographically-based findings of the physical climate risk research. We are building tools for sovereign debt analysts to systematically visualize expected changes in acute and chronic physical climate risks to the countries in which they invest. All else equal, we expect climate vulnerabilities to influence the investment decision between two securities with otherwise similar fundamental characteristics.

Corporate (financial)

We provide central ESG integration resources to portfolio teams firm-wide, and we approach ESG integration as a tailored process that can be applied to all asset classes. We do this by analyzing ESG risks and opportunities in our clients' portfolios and engaging with companies in which we invest to discuss material ESG issues. Wellington Management's culture is built to support collaboration and our open-architecture "community of investors" naturally lends itself to the integration of ESG considerations. 

Our ESG Research team, part of the central Investment Research function, helps our portfolio managers and analysts gather deeper intelligence on ESG topics and integrate these considerations into the investment process. We believe that a holistic understanding of how companies deploy capital - financial, physical, and human - is helpful in framing an investment thesis, and examining ESG issues gives us a more complete picture. Our ESG analysts are responsible for conducting in-depth analysis of the ESG factors most relevant to the sectors within their coverage area. They are also responsible for coordinating the ESG engagement strategies for the companies in their sectors with equity and fixed income analysts and portfolio managers. Our ESG team works closely with investment teams to incorporate our research into the investment process - regularly conducting in-depth portfolio reviews with investment teams to discuss holdings with the greatest ESG risks and strengths.

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security, as well as within company engagement efforts.

The ESG Research team has been incorporated into several key elements of the credit research process and information flow, facilitating more real-time integration. For example, ESG analysts are included in emails announcing new issues. Credit analysts provide their opinion on the new issue for interested portfolio managers, and ESG analysts can add material takeaways from recent research and engagement. Weekly corporate credit meetings are open to others in Investment Research, including ESG analysts. This provides another forum for ESG issues to be discussed at the security level.

Our Climate Research team conducts climate portfolio reviews to assess the physical climate risk of the holdings we own on behalf of clients.  This process allows portfolio managers to make better informed investment decisions and facilitates more robust engagement on physical climate risk issues.  In addition, we have reviewed the carbon footprint of each of our representative accounts.   Portfolio managers can use this to assess their portfolio’s footprint and the largest contributors.  This too enables more informed investment decisions.

Corporate (non-financial)

We provide central ESG integration resources to portfolio teams firm-wide, and we approach ESG integration as a tailored process that can be applied to all asset classes. We do this by analyzing ESG risks and opportunities in our clients' portfolios and engaging with companies in which we invest to discuss material ESG issues. Wellington Management's culture is built to support collaboration and our open-architecture "community of investors" naturally lends itself to the integration of ESG considerations. 

Our ESG Research team, part of the central Investment Research function, helps our portfolio managers and analysts gather deeper intelligence on ESG topics and integrate these considerations into the investment process. We believe that a holistic understanding of how companies deploy capital - financial, physical, and human - is helpful in framing an investment thesis, and examining ESG issues gives us a more complete picture. Our ESG analysts are responsible for conducting in-depth analysis of the ESG factors most relevant to the sectors within their coverage area. They are also responsible for coordinating the ESG engagement strategies for the companies in their sectors with equity and fixed income analysts and portfolio managers. Our ESG team works closely with investment teams to incorporate our research into the investment process - regularly conducting in-depth portfolio reviews with investment teams to discuss holdings with the greatest ESG risks and strengths.

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security, as well as within company engagement efforts.

The ESG Research team has been incorporated into several key elements of the credit research process and information flow, facilitating more real-time integration. For example, ESG analysts are included in emails announcing new issues. Credit analysts provide their opinion on the new issue for interested portfolio managers, and ESG analysts can add material takeaways from recent research and engagement. Weekly corporate credit meetings are open to others in Investment Research, including ESG analysts. This provides another forum for ESG issues to be discussed at the security level.

Our Climate Research team conducts climate portfolio reviews to assess the physical climate risk of the holdings we own on behalf of clients.  This involves an analysis of company disclosure, and a comparison to our climate research findings, to determine the materiality of a company’s climate risk and current management of climate exposure. This process allows portfolio managers to make better informed investment decisions and facilitates more robust engagement on physical climate risk issues.  In addition, we have reviewed the carbon footprint of each of our representative accounts.   Portfolio managers can use this to assess their portfolio’s footprint and the largest contributors.  This too enables more informed investment decisions.

Securitised

In 2017, the ESG team hired an experienced analyst from Wellington's municipal credit analysis team, which has greatly increased the team's focus on fixed income and securitized assets specifically.

Each of our portfolio managers develops their own investment approach whereby ESG considerations are integrated into their research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns. This can manifest itself within the investment thesis or portfolio weighting for a particular security.

There has been particular interest and involvement from the securitized teams in the physical climate risk research being conducted with Woods Hole Research Center (WHRC). This is driven by a number of factors, including the longer holding period and lower liquidity of certain holdings. Given that some segments of the securitized market are geographically concentrated, there is strong alignment in the geographically-based findings of the physical climate risk research as well.  We are building tools for investors to systematically map securitized holdings overlaid onto expected changes in acute and chronic physical climate risks. All else equal, we expect climate vulnerabilities to influence the investment decision between two securities with otherwise similar fundamental characteristics.

12.3. Additional information.[OPTIONAL]


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