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Pendal

PRI reporting framework 2020

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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
96 Integration alone
2 Screening + integration strategies
1 Thematic + integration strategies
0 Screening + thematic strategies
1 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (financial)
0 Screening alone
0 Thematic alone
94 Integration alone
3 Screening + integration strategies
1 Thematic + integration strategies
0 Screening + thematic strategies
2 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (non-financial)
0 Screening alone
0 Thematic alone
95 Integration alone
3 Screening + integration strategies
1 Thematic + integration strategies
0 Screening + thematic strategies
1 All three strategies combined
0 No incorporation strategies applied
100%

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

Pendal’s philosophy for all our fixed income (FI) Funds is that where ESG factors are considered material to risk and return outcomes they are incorporated into the investment process. Time horizons and materiality of ESG factors varies across asset classes as well as by strategy within FI. For example, the value added from incorporating ESG factors into fixed interest analysis relates more to risk mitigation than other asset classes. In addition, we have also found the value added from an ESG incorporation strategy is more material to credit than to developed market SSA.

We have 5 types of ESG strategies:

  1. ESG incorporation
  2. Exclusion screens
  3. Sustainable (Best of Sector)
  4. ESG Thematic - Green, Social, Sustainability Bonds
  5. Active ownership/Engagement: directly & indirectly (via our Equity teams, Regnan)

The choice and combination of ESG strategies above is tailored to align with our views of how we can best manage the values and value (risk/return) objectives for the portfolio / clients.

Our process utilises internal ESG resources, including ESG data from Regnan, analysis from our equity teams, and insight from ESG specialists within our Investments and Product teams, along with external ESG resources including ESG research provided by MSCI and Rating Agencies.

01.3. Additional information [Optional].


FI 02. ESG issues and issuer research

02.1. Indicate which ESG factors you systematically research as part of your analysis on issuers.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Environmental data
Social data
Governance data

02.2. Indicate what format your ESG information comes in and where you typically source it

Indicate who provides this information  

Indicate who provides this information  

Indicate who provides this information  

Indicate who provides this information  

02.3. Provide a brief description of the ESG information used, highlighting any differences in sources of information across your ESG incorporation strategies.

We utilise a number of both internal and external sources of ESG information as outlined below:

Internal

  • ESG Research: proprietary research developed by Regnan to support ESG integration, sustainability assessments, and ethical screening.
  • ESG Specialists: the Regnan team, Pendal Australia's Responsible Investments team, and specialists within our Investment, Services and Oversight and Product teams.
  • Responsible Investment Working Group: this cross-function group monitors and reviews industry trends, standards, issues and practices that are relevant to the maintenance and development of Pendal's RI framework.
  • Pendal's Equity teams: provide a significant internal resource that engages with investee company management directly and share insights across ESG issues. Credit portfolio managers and analysts also perform ESG analysis and engagement with issuers.

External:

  • ESG Research: provided by third party ESG service providers to support ESG integration, sustainability assessments, and ethical screening.
  • Ratings Agencies: have begun to incorporate ESG factors into their credit ratings process. This is increasingly becoming an important additional ESG resource.
  • Industry, Academia and Broker research: where relevant to investment strategy and as a best practice reference

 

02.4. Additional information. [Optional]

We engage with external research providers to stimulate research on how ESG factors can be better incorporated into fixed income investment frameworks to achieve better risk/return outcomes for our clients. We also engage with issuers to encourage better reporting practices as well as to support the pipeline for ESG/sustainable/impact-related structures in fixed income. For example; our ESG Fixed Income Portfolio Managers have participated in a number of ESG forums and contributed to a PRI published report on ESG factors in Credit risk ratings and analysis. See link below:

https://www.pendalgroup.com/education-and-resources/investing-responsibly-a-case-study-on-assessing-credit-risk/

We also encourage a two-way dialogue with sell-side research providers and frequently suggest ESG themes and tools of interest at an issuer level as well as at a sector and asset class levels.

 


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]

The FI investment framework incorporates ESG factors into the investment process through bottom up analysis:

  • Credit research: incorporates fundamental issuer analysis and quantitative modelling to identify investment opportunities whilst avoiding deteriorating credits. Analysis focuses on business profile (including any material ESG issues) as well as financial profile and valuations.
  • SSA research: incorporates fundamental issuer analysis of material ESG issues.
  • Collaboration with Pendal's Australian Equities team and a third party global research house is an important component in the credit research process.

Portfolio construction combines the bottom up steps outlined above. Important considerations in portfolio construction include: correlations; issuer & sector diversification; concentration; position sizing; liquidity; ability to hedge; tracking error; investment horizon; and valuation.

 


(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)
Negative/exclusionary screening
Positive/best-in-class screening
Norms-based screening

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

  • Our Ethical/Exclusionary screening approach screens issuers based on material business involvement in activities, the most common being tobacco, alcohol, gaming, weapons, pornography, thermal coal and oil sands. Materiality is typically 10% of revenue.
  • All things being equal, we apply an active positive tilt on issuers who rank high on sustainability scores, Issuers with low scores will be excluded.
  • In addition, "Use of Proceeds" holdings go through a two-step process where we assess the sustainability of the issuer and the security - both steps need to be cleared for a security to be deemed investable. The security is deemed investable if it is certified Green, Climate, Social or Sustainable based on an approved industry standard (e.g. Climate Bond Initiative or International Capital Markets Association Green Bond Principles).
  • Screening criteria is applied every month and portfolio changes are communicated in the monthly performance reports.

04.3. Additional information. [Optional]


FI 05. Examples of ESG factors in screening process

05.1. Provide examples of how ESG factors are included in your screening criteria.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

Select fixed income funds will not invest in issuers with material business involvement in the extraction of thermal coal and oil sands production. We generally consider that an issuer has a material business involvement in an activity if 10% or more of its total revenue is derived from that activity.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

Select fixed income funds will not invest in issuers with material business involvement in manufacture or provision of gaming facilities, due to social harms from gambling. We generally consider that an issuer has a material business involvement in an activity if 10% or more of its total revenue is derived from that activity.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

Select fixed income funds will not invest in issuers with unethical business conduct and poor governance, as determined through our proprietary sustainability assessment.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

Select fixed income funds positively screen for issuance relating to products or services which contribute to positive environmental outcomes. For example, we actively seek opportunities to invest in Green Bonds and other sustainability bonds, which support climate change, water security and other environmental benefits.

Type of fixed income

ESG factors

Screening

Description of how ESG factors are used as the screening criteria

Select fixed income funds positively screen for issuance relating to products or services which contribute to positive social outcomes. For example, we actively seek opportunities to invest in Social Bonds and corporate debt which supports education, affordable housing and other benefits to the community.

05.2. Additional information.


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

06.2. Additional information. [Optional]

The audit of fund holdings for screening purposes are addressed through Pendal’s annual internal controls report (GS007) The controls are tested on a sample basis and include the controls covering the establishment of investment guidelines system and monitoring and escalation of breaches.


(B) Implementation: Thematic

FI 07. Thematic investing - overview (Private)


FI 08. Thematic investing - themed bond processes

08.1. Indicate whether you encourage transparency and disclosure relating to the issuance of themed bonds as per the Green Bonds Principles, Social Bond Principles, or Sustainability Bond Guidelines..

          Certification according to CBI or IMCA Principles
        

08.2. Describe the actions you take when issuers do not disburse bond proceeds as described in the offering documents.

Following a breach in issuer obligations we will sell down the holding unless the issuer can rectify immediately and provide credible evidence of why it will not occur again.

08.3. Additional information. [Optional]


FI 09. Thematic investing - assessing impact

09.1. Indicate how you assess the environmental or social impact of your thematic investments.

          At this point we do not conduct additional due diligence other than ensuring issuer certification protocol adherence (assurance of CBI and IMCA Green Bond Principles)
        

09.2. Additional information. [Optional]

We are currently trialling research providers in the big data/AI space, in addition to providers of specialist thematic research such as physical impacts of climate change.


(C) Implementation: Integration

FI 10. Integration overview

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

The FI investment process draws on bottom-up analysis. This applies to all of our Fixed Income assets managed in Australia.

Bottom-up components include:

  • Credit research: incorporates fundamental issuer analysis and quantitative modelling to identify investment opportunities whilst avoiding deteriorating credits. The analysis focuses on business profile (including any material ESG issues) as well as the financial profile and valuations.
  • Collaboration with Pendal's Equity teams and a third party global research house is an important component in the credit research process.

Portfolio construction combines the bottom-up steps outlined above. Important considerations in portfolio construction include: correlation to existing portfolio; issuer diversification; concentration; position sizing; the liquidity of the portfolio; ability to hedge; sector diversification; tracking error; and valuation. Stop loss/take profit limits are identified for each active position. When implementing trades the investment horizon, market positioning, momentum, and technical analysis are incorporated. The focus is on identifying catalysts which can make the trades effective and realise value for the fund.

We have found that the value added from incorporating ESG considerations into fixed income strategies relates more to risk mitigation than other asset classes and that the relevance for a strategy with a short-term investment objective will be considerably less than a longer term horizon.

Our Responsible Investments team works closely with all of our investment teams to ensure each team's incorporation of ESG factors is relevant and consistent with the Pendal Australia's overall RI Philosophy. Information is shared across the asset class teams where ESG information synergies also exist, for example, between our credit and equity analysts. Our RI Working Group is another forum that fosters ongoing and open dialogue across the investment teams and key support teams to ensure relevant ESG information is being incorporated into our investment products, policies and processes.

 

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

SSA

We assess ESG factors across our SSA holdings. In addition, we have developed a proprietary framework for our Australian strategies given the significant proportion of Government securities in our Australian composite fixed interest funds.

The Federal and State Governments in Australia generally have strong governance and social scores on an international comparison. However, the environmental scores are lower on an international basis and vary more across States. Following on from this analysis our investment team identified opportunities to add value from a risk/return perspective at a State Issuer level based on these identified environmental issues. 

An example of our scores are represented below which then translate into our active positioning vs benchmark which is in the second graph. Traditional framework (MSCI scoring system) is 50% Governance, 25% Environment and 25% Social. Australia rates highly for governance and social but poorer for environment. Therefore for internal state ratings, we make it 50% environment and 25% for social and governance. A score of 1 in the table below is the strongest score:

                    Environment   Governance   Social   Total      % Female MPs
TAS                      1                      2                  3        1.75                 50
ACT                     2                      2                  1        1.75                 56
Commonwealth 3                      2                  2         2.5                   33

In addition, Pendal is engaging with State borrowing authorities to support issuance of specific purpose bonds and reflect the importance of ESG scores to our investment process.

Corporate (financial)

Drilling down further on the process outlined in FI 10.1 above, the top-down and bottom-up components provide additional information on how ESG factors are incorporated into our analysis of corporate (financial) issuers:

Top-down: the Credit Macro View is determined through other macro credit fundamentals; such as credit specific economic data, company earnings, balance sheet health, default rates and equity volatility. The results of the macro input stage determine a credit market view (positive, neutral, or negative) which influences the sector weightings (defensive versus cyclical sectors) and credit rating tilt. Once preferred sector exposures have been determined, it is combined with the bottom-up issuer research and culminates in issuer and then security selection.

Bottom-up: The credit research process incorporates fundamental issuer analysis (including ESG factors where they are material to the financial outcomes of the investment) and quantitative issuer modelling to identify investment opportunities whilst avoiding deteriorating credits. Collaboration with the Pendal's Australian Equities team and a third party global research house is an important component in the process. The bottom-up credit analysis focuses on business profile (ESG factors, industry factors, competition, business diversity), financial profile (earnings and cashflow volatility, balance sheet) and valuations. The credit research process culminates with analysts formalising a view on each applicable issuer based on both their fundamental strength and relative value versus both industry and peers. The aim is to identify which securities are the most attractive from a risk/return perspective.

Our Head of Responsible Investments works closely with all of our investment teams to ensure each team’s incorporation of ESG factors is relevant and consistent with the Pendal Australia’s overall RI Philosophy. Information is Our Responsible Investments team works closely with all of our investment teams to ensure each team's incorporation of ESG factors is relevant and consistent with the Pendal Australia's overall RI Philosophy. Information is shared across the asset class teams where ESG information synergies also exist, for example between our credit and equity analysts. This includes ESG information gathered from our Equity team engagements. Our RI Working Group is another forum that fosters ongoing and open dialogue across the investment teams and key support teams to ensure relevant ESG information is being incorporated into our investment products, policies and processes.

.

Corporate (non-financial)

 Drilling down further on the process outlined in FI 10.1, the above top-down and bottom-up components provide additional information on how ESG factors are incorporated into our analysis of corporate (non-financial) issuers:

Top-down: the Credit Macro View is determined through other macro credit fundamentals; such as credit specific economic data, company earnings, balance sheet health, default rates and equity volatility. The results of the macro input stage determine a credit market view (positive, neutral, or negative) which influences the sector weightings (defensive versus cyclical sectors) and credit rating tilt. Once preferred sector exposures have been determined, it is combined with the bottom-up issuer research and culminates in issuer and then security selection

Bottom-up: The credit research process incorporates fundamental issuer analysis (including ESG factors where they are material to the financial outcomes of the investment) and quantitative issuer modelling to identify investment opportunities whilst avoiding deteriorating credits. Collaboration with the Pendal's Australian Equities team and a third party global research house is an important component in the process. The bottom-up credit analysis focuses on business profile (ESG factors, industry factors, competition, business diversity), financial profile (earnings and cashflow volatility, balance sheet) and valuations. The credit research process culminates with analysts formalising a view on each applicable issuer based on both their fundamental strength and relative value versus both industry and peers. The aim is to identify which securities are the most attractive from a risk/return perspective.

Our Responsible Investments team works closely with all of our investment teams to ensure each team's incorporation of ESG factors is relevant and consistent with the Pendal Australia's overall RI Philosophy. Information is shared across the asset class teams where ESG information synergies also exist, for example between our credit and equity analysts. This includes ESG information gathered from our Equity team engagements. Our RI Working Group is another forum that fosters ongoing and open dialogue across the investment teams and key support teams to ensure relevant ESG information is being incorporated into our investment products, policies and processes.

.

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)
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]


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

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

SSA

Our process for reviewing ESG factors in our SSA integration process is based on an analysis of those factors we believe to be material to the risk/return outcomes of that issuer. As part of this process, we utilise internal and external information sources. In addition, Pendal engages with SSA borrowing authorities to enhance our understanding of a particular issuer's exposure to current or emergent ESG issues and how well the issuer is managing those exposures. Where appropriate we will encourage the adoption of formal policies and enhanced disclosure to assist in the management and assessment of ESG issues.

For example, in late 2019, the investment team and Regnan (our internal ESG research team) have been working on a new factor to add to our “Environmental” score for governments in Australia. This factor is Water Security across the states given that we view this will be an important determinant in potential credit rating changes in the future. This research project is focussing on a number of elements that will drive our assessment of Water Security across the state governments.

 

 

Corporate (financial)

Our credit analysis process incorporates fundamental issuer analysis and proprietary quantitative modelling to assess investment opportunities. In particular, the credit selection framework focuses on four categories:
1. Business profile (such as competitive position and quality of management);
2. Financial profile (such as cash flow metrics and debt maturity schedules);
3. Risk factors (including regulation and funding sources); and
4. Valuation factors (such as relative value, technical and covenant strength).

ESG factors are typically captured in the business profile and risk factor categories where they are deemed material to the financial outcomes of the fund using bottom-up analysis. Examples of some of the categories that may be considered (depending on specific sector, business factors, investment horizon, geographic exposures, regulatory factors, and product performance objectives) include:

  • Environmental Management:
    • management of environmental impacts through the implementation of best practice environmental techniques, technologies and product design;
    • environmental performance against a range of environmental indicators including for example, greenhouse gas emissions, energy and water use and environmental incidents;
    • the capacity to consult key stakeholders in relation to activities that may have significant environmental impacts; and
    • adoption of best practice with regards to management and disclosure of material risks and opportunities associated with climate change.
  • Social practices:
    • equal opportunity, anti-discrimination and industrial relations policies and practices;
    • staff incentives, development and training;
    • employee benefits and entitlements;
    • human capital management performance against a range of indicators, such as voluntary turnover and gender diversity in senior management;
    • products or services that provide positive social impacts such as improved health & community well-being, disease prevention, and education; 
    • management of contractors and suppliers; and
    • workplace health and safety performance against indicators such as fatalities and lost time injury frequency rates.
  • Corporate governance and business conduct:
    • codes of conduct and the extent of their integration into the company’s operations;
    • provision of regular and appropriate training;
    • whistleblower policies and procedures;
    • ethical conduct and performance of employees and officers - the extent to which companies are adopting principles in areas such as complying with the law, fair and open dealings and accepting responsibility for their actions;
    • product safety and consumer protection; and
    • engagement practices with employees, shareholders and key community stakeholders.

For our review of ESG factors for credit, collaboration with Pendal's Equities teams is an important component in the credit research process. ESG data and research from Regnan is also used to enhance our own research and analysis of ESG factors.

In addition to the above, our Responsible Investments Working Group facilitate knowledge sharing and provide input into RI guidelines, strategy and solutions. The group consists of senior members of the investments (all asset classes) and corporate teams (Risk & Compliance, Legal, Sales and Marketing) and its responsibilities are set out in the Responsible Investments Governance Structure. The objective of the group is to review the development and application of Pendal's RI process across offerings and communications, to ensure alignment with Pendal's RI philosophy as well as client expectations and needs. The group does not replace prior risk management and compliance processes, however, serves to enhance the existing controls already in place.

Corporate (non-financial)

Our credit analysis process incorporates fundamental issuer analysis and proprietary quantitative modelling to assess investment opportunities. In particular, the credit selection framework focuses on four categories:
1. Business profile (such as competitive position and quality of management);
2. Financial profile (such as cash flow metrics and debt maturity schedules);
3. Risk factors (including regulation and funding sources); and
4. Valuation factors (such as relative value, technical and covenant strength).

ESG factors are typically captured in the business profile and risk factor categories where they are deemed material to the financial outcomes of the fund using bottom-up analysis. Examples of some of the categories that may be considered (depending on specific sector, business factors, investment horizon, geographic exposures, regulatory factors, and product performance objectives) include:

Environmental Management:

  • management of environmental impacts through the implementation of best practice environmental techniques, technologies and product design;
  • environmental performance against a range of environmental indicators including for example, greenhouse gas emissions, energy and water use and environmental incidents;
  • the capacity to consult key stakeholders in relation to activities that may have significant environmental impacts; and
  • adoption of best practice with regards to management and disclosure of material risks and opportunities associated with climate change.

Social practices:

  • equal opportunity, anti-discrimination and industrial relations policies and practices;
  • staff incentives, development and training;
  • employee benefits and entitlements;
  • human capital management performance against a range of indicators, such as voluntary turnover and gender diversity in senior management;
  • products or services that provide positive social impacts such as improved health & community well-being, disease prevention, and education; 
  • management of contractors and suppliers; and
  • workplace health and safety performance against indicators such as fatalities and lost time injury frequency rates.

Corporate governance and business conduct:

  • codes of conduct and the extent of their integration into the company’s operations;
  • provision of regular and appropriate training;
  • whistleblower policies and procedures;
  • ethical conduct and performance of employees and officers - the extent to which companies are adopting principles in areas such as complying with the law, fair and open dealings and accepting responsibility for their actions;
  • product safety and consumer protection; and
  • engagement practices with employees, shareholders and key community stakeholders.

For our review of ESG factors for credit, collaboration with Pendal's Equities teams is an important component in the credit research process. ESG data and research from Regnan is also used to enhance our own research and analysis of ESG factors.

In addition to the above, our Responsible Investments Working Group facilitate knowledge sharing and provide input into RI guidelines, strategy and solutions. The group consists of senior members of the investments (all asset classes) and corporate teams (Risk & Compliance, Legal, Sales and Marketing) and its responsibilities are set out in the Responsible Investments Governance Structure. The objective of the group is to review the development and application of Pendal's RI process across offerings and communications, to ensure alignment with Pendal's RI philosophy as well as client expectations and needs. The group does not replace prior risk management and compliance processes, however, serves to enhance the existing controls already in place.

12.3. Additional information.[OPTIONAL]


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