When assessing sovereign bonds we consider governance and social factors such as a country’s political stability and cohesion and the credibility of its political and monetary institutions. We consider that these factors which effectively constitute and underpin a country’s governance are fundamental to sovereign credit analysis, so it is intuitive that our fund mangers take the lead on ESG integration, supported by the GS Team. The sovereign analysts will often conduct research trips to engage with government departments, local corporates, policy makers, NGOs and multilateral institutions to understand these risks. This applies to both G10 and emerging sovereigns. Material ESG factors assessed will be communicated in the investment memo and form part of the decision whether or not to invest. We pay particular attention to the risk of sanctions being imposed, either on sovereigns or quasi-sovereign entities themselves or on individuals associated with the sovereign. We conduct engagement and analysis to inform our understanding of these idiosyncratic risks.

An important consideration in global bond markets is the political cycle in the different economies in which we invest and the extent to which this can drive policy changes affecting sovereign and corporate issuers in the portfolio. The fund manager pays close attention to these developments which can incorporate of economic factors, such as fiscal and monetary policy, but also a wide and varied range of ESG considerations. The latter may include transition risk relating to future changes in energy policy, social factors which may underpin political support for a political administration, or demographic trends which may influence monetary or fiscal policy, and thus impact bond prices. These broader themes can play a role in portfolio construction at any given time and the fund manager integrates this analysis into the continuous process of economic research and monitoring over time. 

The heterogeneity of our investable universe precludes the use of a ‘one size fits all’ approach to ESG analysis. Our analysts tailor their approach to the different instruments, sectors and geographies in which we invest. Our approach to monitoring and engagement varies depending on the type of security being considered.

We have a significant allocation to financials within our fixed income funds which can and have historically represented material ESG risks such as those relating to conduct, governance, misaligned incentives and regulatory or criminal fines. Our Head of Credit Research oversees our financials allocation and his credit selection and monitoring is informed by his significant experience of managing these risks and assessing their materiality to investment outcomes. He can also draw on external data such as RepRisk and the input of the GS team.

Below are themes that may arise in our ESG analysis and engagement with investee companies, including both financial and non-financial corporates. This does not represent an exhaustive list but indicates how stewardship factors are incorporated into the team’s process.

• The strategic track record of the management team and prevalent corporate culture with regard to risk appetite, conduct, safety and regulation.
• The track record and credibility of the issue sponsor with regards to respecting bondholder rights.
•  Assessment of remuneration disclosures, where these are available, to consider executive alignment.
•  Ownership structures, such as the reputation of the controlling shareholder and their degree of control over a company’s board, the level of employee ownership and other factors which may indicate the level of alignment with bondholders.
•  Controversies, jurisdictional risks and the management of social and environmental risk factors which may affect the evolution of a company’s credit risk over time.

The heterogeneity of our investable universe precludes the use of a ‘one size fits all’ approach to ESG analysis. Our analysts tailor their approach to the different instruments, sectors and geographies in which we invest. Our approach to monitoring and engagement varies depending on the type of security being considered. The level of ESG disclosures varies considerably between the different asset classes and geographies in which we invest. For example, there are typically fewer ESG disclosures in the high yield market due to the prevalence of private companies. We utilise direct engagement with issuers to gain investment insights and to understand relevant ESG considerations.

In the oil and gas exploration and production sector, for example, our approach is informed by uncertainty over the prospects for global oil demand in the coming decades. This is based on structural declines in oil consumption driven by increased vehicle fuel efficiency and by the transition to electrification of ground transportation.

This macro view influences our investment approach and our views on credit quality in the sector in several ways:

• We look to invest in bonds with short maturities (typically less than five years) to reduce our exposure to longer-term oil demand trends.
• We select issuers with cost-advantaged operations which are likely to be more resilient in a rapid energy transition scenario.
• We look for companies with robust commodity price hedging programmes and management teams that favour capital preservation and balance sheet deleveraging over shareholder distributions.
• We assess whether potential investee companies have strong track records for operational health, safety, security and environment (HSSE).

The energy transition theme and the possibility of tougher regulatory measures feed into our views on industrials, where we are cautious on companies with highly energy intensive business models. Many ‘traditional’ industrials, such as generic steel producers, fall into this category. We incorporate the impact of higher input prices into our models and consider risks around carbon credit costs. We view companies with robust commodity price hedging programmes favourably as this can reduce risk around short to medium term fluctuations in prices. We are currently researching potential investment ideas among industrials with more resilient business models, such as companies with upstream integration into clean power generation.

In the power sector, we are conscious of the structural decline of coal versus growth in renewables when assessing credits. We have a very negative view on thermal coal, even in emerging markets where it currently remains dominant, as we observe that the same structural issues are present albeit on a more distant timescale. In contrast, we see significant investment opportunities in emerging markets that are rolling out renewable energy programmes, such as India, Argentina and Eastern Europe.

In emerging markets, governance factors are a critical component of the analysis. We look for companies which we consider are likely to benefit from a lender of last resort, such as issuers which enjoy strong levels of government support. We will also consider the reputation and any political affiliations of major shareholders which might affect our investments. We pay particular attention to the risk of sanctions being imposed, either on the companies themselves or on individuals associated with them. We conduct engagement and analysis to inform our understanding of these idiosyncratic risks.

The approach to ESG integration is identical to the approach to traditional corporate bonds as described above.

When assessing sovereign bonds we consider governance and social factors such as a country’s political stability and cohesion and the credibility of its political and monetary institutions. We consider that these factors which effectively constitute and underpin a country’s governance are fundamental to sovereign credit analysis, so it is intuitive that our fund mangers take the lead on ESG integration, supported by the GS Team. The sovereign analysts will often conduct research trips to engage with government departments, local corporates, policy makers, NGOs and multilateral institutions to understand these risks. This applies to both G10 and emerging sovereigns. Material ESG factors assessed will be communicated in the investment memo and form part of the decision whether or not to invest. We pay particular attention to the risk of sanctions being imposed, either on sovereigns or quasi-sovereign entities themselves or on individuals associated with the sovereign. We conduct engagement and analysis to inform our understanding of these idiosyncratic risks.

An important consideration in global bond markets is the political cycle in the different economies in which we invest and the extent to which this can drive policy changes affecting sovereign and corporate issuers in the portfolio. The fund manager pays close attention to these developments which can incorporate of economic factors, such as fiscal and monetary policy, but also a wide and varied range of ESG considerations. The latter may include transition risk relating to future changes in energy policy, social factors which may underpin political support for a political administration, or demographic trends which may influence monetary or fiscal policy, and thus impact bond prices. These broader themes can play a role in portfolio construction at any given time and the fund manager integrates this analysis into the continuous process of economic research and monitoring over time. 

The heterogeneity of our investable universe precludes the use of a ‘one size fits all’ approach to ESG analysis. Our analysts tailor their approach to the different instruments, sectors and geographies in which we invest. Our approach to monitoring and engagement varies depending on the type of security being considered.

We have a significant allocation to financials within our fixed income funds which can and have historically represent material ESG risks such as those relating to conduct, governance, misaligned incentives and regulatory or criminal fines. Our Head of Credit Research oversees our financials allocation and his credit selection and monitoring is informed by his significant experience of managing these risks and assessing their materiality to investment outcomes. He can also draw on external data such as RepRisk and the input of the GS team.

Below are themes that may arise in our ESG analysis and engagement with investee companies, including financials. This does not represent an exhaustive list but indicates how stewardship factors are incorporated into the team’s process.

• The strategic track record of the management team and prevalent corporate culture with regard to risk appetite, conduct, safety and regulation.
• The track record and credibility of the issue sponsor with regards to respecting bondholder rights.
• Assessment of remuneration disclosures, where these are available, to consider executive alignment.
• Ownership structures, such as the reputation of the controlling shareholder and their degree of control over a company’s board, the level of employee ownership and other factors which may indicate the level of alignment with bondholders. 
• Controversies, jurisdictional risks and the management of social and environmental risk factors which may affect the evolution of a company’s credit risk over time.

The heterogeneity of our investable universe precludes the use of a ‘one size fits all’ approach to ESG analysis. Our analysts tailor their approach to the different instruments, sectors and geographies in which we invest. Our approach to monitoring and engagement varies depending on the type of security being considered. The level of ESG disclosures varies considerably between the different asset classes and geographies in which we invest. For example, there are typically fewer ESG disclosures in the high yield market due to the prevalence of private companies. We utilise direct engagement with issuers to gain investment insights and to understand relevant ESG considerations.

In the oil and gas exploration and production sector, for example, our approach is informed by uncertainty over the prospects for global oil demand in the coming decades. This is based on structural declines in oil consumption driven by increased vehicle fuel efficiency and by the transition to electrification of ground transportation.

This macro view influences our investment approach and our views on credit quality in the sector in several ways:

• We look to invest in bonds with short maturities (typically less than five years) to reduce our exposure to longer-term oil demand trends.
• We select issuers with cost-advantaged operations which are likely to be more resilient in a rapid energy transition scenario.
• We look for companies with robust commodity price hedging programmes and management teams that favour capital preservation and balance sheet deleveraging over shareholder distributions.
• We assess whether potential investee companies have strong track records for operational health, safety, security and environment (HSSE).

The energy transition theme and the possibility of tougher regulatory measures feed into our views on industrials, where we are cautious on companies with highly energy intensive business models. Many ‘traditional’ industrials, such as generic steel producers, fall into this category. We incorporate the impact of higher input prices into our models and consider risks around carbon credit costs. We view companies with robust commodity price hedging programmes favourably as this can reduce risk around short to medium term fluctuations in prices. We are currently researching potential investment ideas among industrials with more resilient business models, such as companies with upstream integration into clean power generation.

In the power sector, we are conscious of the structural decline of coal versus growth in renewables when assessing credits. We have a very negative view on thermal coal, even in emerging markets where it currently remains dominant, as we observe that the same structural issues are present albeit on a more distant timescale. In contrast, we see significant investment opportunities in emerging markets that are rolling out renewable energy programmes, such as India, Argentina and Eastern Europe.

In emerging markets, governance factors are a critical component of the analysis. We look for companies which we consider are likely to benefit from a lender of last resort, such as issuers which enjoy strong levels of government support. We will also consider the reputation and any political affiliations of major shareholders which might affect our investments. We pay particular attention to the risk of sanctions being imposed, either on the companies themselves or on individuals associated with them. We conduct engagement and analysis to inform our understanding of these idiosyncratic risks.

In emerging markets, governance factors are a critical component of the analysis. We look for companies which we consider are likely to benefit from a lender of last resort, such as issuers which enjoy strong levels of government support. We will also consider the reputation and any political affiliations of major shareholders which might affect our investments. We pay particular attention to the risk of sanctions being imposed, either on the companies themselves or on individuals associated with them. We conduct engagement and analysis to inform our understanding of these idiosyncratic risks.

The approach to ESG integration and review is identical to the approach to traditional corporate bonds as described above.