The Principles for Responsible Investment (PRI) has written this practical guide to help fixed income managers and asset owners practice responsible investment (RI). This paper explains how investors can integrate ESG analysis into their risk management and decision-making for corporate and non-corporate bonds, discussing how to measure various ESG criteria for each issuer type and the practical use of this information. Drawing upon leading practices from PRI’s global network of signatories, this paper identifies a number of fundamental trends that will help investors develop their own style of RI in fixed income.

The guide starts off by looking at the motivations and applications of RI in fixed income. Motivations for RI are seen to vary from the pursuit of financial value to ethical motivations and reputational concerns. The report highlights how these should be acted upon indirectly through asset owners or directly through investment managers. The guide notes the unique characteristics between asset classes, providing examples of responsible investment actions and how investors can use these to tailor their own RI approach.

Moving into the investment process, the paper explains why fixed income investors should integrate ESG into issuer analysis, and how to implement this, specifically regarding issuer creditworthiness. ESG issues such as corruption and climate change are potential risks that may affect an issuers ability to repay its debt. Thus, these factors must be considered when making investment decisions.

Practical examples and key considerations are provided to show how to integrate ESG into analysis across a range of issuers effectively, including:

• Government issuers
• Municipal issuers
• Supranational issuers
• Corporate (non-financial issuers)

The paper looks at how fixed income investors are applying ESG filters or screens to their investment universe. These are used to ensure investments are aligned with their clients’ ethical motivations. Identifying the three most common types of approaches as negative, positive and norms-based screening, the report gives practical examples across corporate, financial sector and government fixed income issuers.

Engagement is another practical approach within RI. The paper notes that engagement is less common among fixed income investors, as opposed to equity, due to a lack of voting power and the position they hold in capital structures. However, both stand to benefit from successful engagements though the mitigation of ESG risks and maximisation of opportunities.

While incorporating ESG concerns into the investment process is critical, investment products can also be used to address ESG risks and sustainability issues. Themed investments such as green bonds or project bonds are examples of investment products that can deliver both attractive returns and more sustainable outcomes. The paper highlights the increasing demand for these ‘themed’ investment products among institutional investors, exploring different types and explaining some key considerations around them that investors should be aware of.

The paper concludes by exploring how fixed income investors can embed RI within their organisations, covering areas such as building teams, providing training, establishing processes and overcoming barriers.

1. Responsible investment is an approach to investment that explicitly acknowledges the relevance of ESG factors and the long-term health and stability of the market as a whole.
2. Investors are starting to tailor their own responsible investment approaches to meet the requirements of different asset classes, whether that be fixed income or equity. ESG integration may be a new concept to many in fixed income, but it is relatively well established among equity investors.
3. In recent years, investors have become aware of the importance of incorporating ESG factors into the analysis of an issuer's creditworthiness. This can not only uncover potential risks that an issuer may not be able to repay its debt, but also shows potential opportunities.
4. When looking at government issuers of fixed income, corruption can be seen as a key indicator of sovereign credit strength because of the relationship between fraud, tax avoidance, financial mismanagement and an issuer’s ability to repay its debt obligations. There are strong correlations between corruption and the number of sovereign defaults.
5. Applying sectors weightings to ESG factors is a great tool to implement into the credit analysis process. Many agree that governance should be weighted most heavily, as these factors relate more closely to management quality and overall creditworthiness.
6. ESG filters or screens are being used by investors to exclude some issuers from their investment universe that are out of line with their clients' priorities. The portfolio managers then decide among what is left, the financial and ESG risk that they are going to take.
7. While engagement is not yet common among fixed income investors, engagements are undertaken to influence (or identify the need to influence) ESG practices and/or improve ESG disclosure, and should be considered in the investment process to mitigate risks and maximise opportunities.
8. Besides incorporating ESG into the investment process there is increasing demand for investment products such as themed investments that deliver both attractive returns and more sustainable outcomes. Green bonds are an example of themed investment products.
9. It is important for investors to fully embed RI within their organisations’ management, research, risk and sales function to ensure that it is applied systematically and is credible to (potential) clients.
10. The PRI prepared this guidance document with two main audiences in mind: first, fixed income investment managers and, second, asset owners such as pension funds and insurers. Their intention is to produce a ‘live document’ whereby readers can email the PRI to contribute case studies and further insights.