1 February 2021
Much of the debate around pension scheme investment strategy and sustainability is focused on the equities held by the scheme. High profile votes by shareholders at company AGMs can give the impression that most of the leverage over companies when it comes to ESG performance comes from those who own the company’s shares.
But, according to new analysis from consultants LCP, the corporate bond market offers another important way of achieving sustainability objectives for a large investor such as a pension scheme. This is not just in the area of actively managed bond portfolios but also longer-term ‘buy and maintain’ holdings of corporate bonds.
With DB pension schemes gradually maturing and de-risking, holdings of bonds are set to increase. At the same time, many companies use the corporate bond market to raise cash as an alternative to issuing new equity (especially with today’s low interest rates). This means that there is a steady flow of companies coming to market seeking to raise funds from investors such as pension schemes. If pension schemes make it clear that they will favour bond issuances by companies with a good and improving sustainability record, this has the potential to drive improved performance by businesses. In addition, because much corporate debt is fixed term and has to be renewed, this offers repeated opportunities to influence the businesses in question.
Where pension schemes invest for the long-term (on a ‘buy and maintain’ basis), they will be particularly interested in the long-term viability and performance of the underlying business. Given the increasing regulatory and societal focus on climate change, investors need to recognise the meaningful medium-term risks in businesses with bad approaches to carbon transition, for example, because the companies may be adversely affected by future regulation or corporate activism.
LCP point out that although there are existing ‘active’ corporate bond strategies which involve buying and selling bonds over the short-term with a focus on sustainability and ESG factors, there are few, if any, similar ‘buy and maintain’ corporate bond strategies designed for long-term investors. This means that investors are missing an opportunity to shape corporate behaviour to maximum effect and to focus on longer-term returns over a period of ten or twenty years or more.
A first step suggested by LCP is for investors to consider instructing their asset managers to reduce the overall carbon intensity of the companies in which they are investing. LCP show that in many cases it is possible to make significant improvements on this metric without compromising the yield of the portfolio. Another interesting outcome of the LCP analysis is the vast range of starting points when it comes to carbon intensity of these portfolios, so it is worth trustees investigating. A more sophisticated approach would be to ensure that the overall asset mix is consistent with the climate goals set out in the Paris Agreement.
Commenting, Jacob Stevens, Senior Consultant at LCP said: “When it comes to sustainable investing, it tends to be equities which grab all the headlines. But there is a steady stream of companies coming to the corporate bond market to borrow money and this provides another opportunity to put pressure on companies to improve their performance when it comes to sustainability. Pension schemes by their nature are long-term investors and can hold corporate bonds for the long-term. Asset managers need to do more to use the power of this flow of investment funds to help schemes to deliver their sustainability objectives”.