The Principles for Responsible Investment (PRI) defines responsible investment as a strategy and practice to incorporate environmental, social and governance (ESG) factors in investment decisions and active ownership. There are many ways to invest responsibly however there is still much confusion around methodology and what is best practice.

The PRI has developed this quick guide, supported with further readings, for investors looking to incorporate responsible investment practices into fixed income investments. The paper outlines options for incorporating ESG into the construction of a fixed income portfolio across three key areas (integration, screening and thematic) as well as how to interact with issuers to provide clarity and direction.

Section one of the paper looks at incorporating ESG issues when building a portfolio and how ESG factors can be incorporated into investment strategies across three approaches: integration, screening and thematic approaches. Investors can select between, or choose a combination of, approaches based on their desired outcome – whether that is to improve the risk return profile, avoid specific sectors, or drive capital towards a particular goal.

The integration approach looks at adding ESG factors into the financial analysis where material ESG factors are identified and assessed alongside traditional financial factors. The paper categorises integration as:

• Investment research – identifies material ESG factors that may impact downside risk;
• Security valuation – integrates the material ESG factors into financial analysis and valuation; and
• Portfolio management – includes the ESG analysis in decisions about risk management and portfolio construction.

The screening approach uses a set of filters to determine which issuers, sectors or activities are eligible or ineligible to be included in a portfolio based on investor preferences, values or ethics. The paper looks at the three most common approaches for screening looking at negative, norms-based and positive screening and outlines the different practices of each.

Finally, the thematic approach identifies and allocates capital to themes or assets related to certain environmental or social outcomes, such as clean energy, energy efficiency or sustainable agriculture. The report uses green bonds as an example of thematic investment products that are rapidly becoming a category of fixed income securities that finance environmental projects.

In combination with incorporating ESG issues into the construction of fixed income portfolios, investors are also able to take active ownerships (stewardship) and interact with issuers on these ESG issues. The paper highlights how even though fixed income investors do not have the same position as equity investors they are still important stakeholders and are able to interact with issuers through the process of engagement.

Through engagement, investors work with issuers to:

• better manage material ESG risks;
• increase the quality of information they disclose on ESG factors, allowing investors to make more informed decisions; and
• improve issuer practices to promote financial or non-financial objectives.

The paper concludes by identifying the different ways investors can engage; what good engagement looks like; the process of engagement; and how they lead to the decision to reinvest or divest as last resort.

1. There are many different approaches for investors to take when incorporating ESG factors into fixed income investment strategies. Investors today are starting to tailor their approaches based on their needs and goals.
2. Integrating ESG factors into the fixed income investments is primarily done to manage downside risk. Investors apply a range of techniques to identify risks that may not appear unless there is careful consideration of ESG data.
3. Traditionally ESG factors have not been well communicated when featured in credit rating methodologies. However, today large rating agencies are starting to increase transparency over how they consider ESG as part of their assessment.
4. Screening can be used to exclude different issuers such as the highest carbon emitters or to target only the lowest emitters.
5. The demand for allocating capital to environmental and social outcomes is growing. Issuers are starting to issue different types of themed fixed income investments such as green bonds, social bonds, sustainability bonds and islamic bonds.
6. Engagement with stakeholders is no longer seen as a tool only for equity investors. Fixed income investors should be practicing active ownership or stewardship where they engage with issuers on different ESG concerns.
7. Fixed income investors can engage individually or in collaboration across all asset classes. This can be through a variety of ways, whether in private meetings or letters between investors and issuers.
8. Engagement is a process that allows fixed income investors to get a better understanding of the relevant ESG issues. It also enables issuers to decide whether or not they should reinvest or divest in the future.