ESG in Fixed Income: A marathon, not a sprint

Janus Henderson’s role as a fixed income manager in relation to ESG

As stewards of our clients’ assets, we need always to be aware of what our clients want. And unsurprisingly, they want different things when it comes to ESG, which reflects their preferences, which, in turn, depends on, for example, the type of client they are, or where they are located. That said, one of the common themes we are seeing is the desire to solve for multiple objectives: investment returns and sustainability.

Clients are asking us to maximise returns for different levels and types of market risks, and sustainability factors. This is where we see our role and our opportunity as an active asset manager because it is what we do every day: maximising returns while minimising risks. In the case of ESG, it can sometimes be more difficult than it first appears, because conversations can get derailed by debates around the weight that should be applied to each objective.

At the same time, our clients do not want to forego returns. They want to know how to be sustainable without hindering returns – or at least minimise any return degradation. Our opportunity here is to help facilitate change towards a more sustainable future, whilst acting in the interests of our clients, and this is what being a global asset manager like Janus Henderson gives you. When it comes to ESG investing, we act globally because we appreciate that no individual regional approach will work for all.

Following the ESG backlash in the United States, what has changed?

In the US, the subject of ESG has been heavily politicised, resulting in some extreme consequences for the investment communities in certain parts of the country. In Europe, there has been some cooling towards ESG, largely driven by energy security concerns, but it is still very much a priority across the continent.

Curiously, one fact to point out is that flows in 2022 into ESG corporate credit funds held up better than flows into non-ESG equivalents, including in the US, and this trend has continued so far into 2023. I think it is important to remind ourselves that ESG is not only about E, or environmental, which has been, essentially, the focus of controversy in the US. It is also very much about S, social, and G, governance factors, both of which are absolutely instrumental in ensuring that a company is a long-term business success.

So, thinking about what has changed. It makes it harder to talk about ESG, which goes back to my point earlier, that as a manager of client money, we are reminded to keep in mind what clients actually want. But we also need to show our clients the meaning behind ESG and that it doesn’t harm investors.

In fixed income at Janus Henderson, our ESG investment philosophy is integration over exclusion. This means that we allocate capital to issuers with varying ESG profiles, not only ESG leaders. We actively engage with companies with higher ESG risk profiles to understand how they are managing these risks. This gives us an opportunity to be more forward looking. It helps us identify improving stories and, at the same time, it creates an opportunity to support transition.

In reality, imposing a blanket exclusion on higher polluting sectors, for example, does not help solve for the broader environmental issues, whereas understanding transition and progress does. We work with companies, therefore, to ensure that the most financially material ESG risks are being managed thoughtfully and progressively. We do this through engaging with them and following up on those engagements.

ESG engagement at JHI Fixed Income

The traditional and original association of engagement and stewardship has largely been with equity holders through their voting rights. However, as bondholders, we help companies access markets for financing their business activities and therefore have a great ability to play a key role in stewardship of our investee companies. For us in fixed income, engagement is integral to our ESG assessment and ultimately feeds into our investment decisions.

We see ESG engagement as fulfilling a dual objective: to ensure we understand how a company is addressing financially material ESG risks and to facilitate positive change. For instance, by challenging a company’s targets and commitments, we help promote transition. We also bring into our engagement with companies the most topical ESG themes prevalent in the markets; those that   investors are concerned with and that are financially material for companies’ business profiles.

Key themes for 2023 and beyond

We constantly monitor the developments of the most topical ESG trends and issues that investors are concerned about. Ultimately, these are driven by broader societal influences and investor sentiment. But for us, it is important to make sure that we focus on what is important to our clients. So, we speak to clients and analyse what questions they raise and what they focus on.

For 2023, we have noted the themes of biodiversity, human rights and labour relations, with a focus on supply chain management, and ESG governance. These are the more prominent themes for 2023 from our perspective.

By ESG governance, by the way, I mean greater scrutiny of targets and commitments that are set by companies. Asking them questions like: How do these ESG targets align with overall company strategy? Or, how is management being held accountable for achieving these targets?

These are, in fact, our engagement themes that we have picked for 2023 that we will be focusing our efforts on across our investee companies as far as they are material to their business profiles.

Another important theme for 2023 is regulation. Both the volume of new key ESG regulation coming in, or expected, and its fragmented nature, is adding to the complexity, both for companies and asset managers.

For instance, looking at the three markets – Europe, the UK and the US – there is no direct comparison between the EU’s Sustainable Financial Disclosure regulation, the proposed Sustainable Disclosure regulation in the UK, and the US SEC’s Fund Categorisation and Disclosure regime. Being global in our approach, Janus Henderson is well positioned, we believe, to navigate this space because we can draw on our deep regional knowledge, giving us the opportunity to respond to this challenge.

Key areas of focus at JHI Fixed Income ESG

Despite the challenges we have discussed in respect of ESG investing, one thing is clear. It isn’t going away. Its pace may have slowed in the US, for example, and it may see some ups and downs still in its journey. But it is here to stay. And global society – our end clients – continue to develop their attitudes towards a more sustainable future. So, our focus must be on being constantly tuned into those developments and on listening to our clients carefully.

We want to make sure that we monitor the broader market ESG trends, including changes in sentiment and societal demands, and that we work with our clients to deliver ESG solutions that they are looking for and that are relevant to them. I think it is important to recognise that ESG is not a sprint; it is a marathon. It must therefore be run consistently and on an inclusive basis. And so, we will continue to support companies, including those in more polluting industries, for example, that are making efforts to transition and to address key material ESG risks, and we will do this through our investment and active engagement with them.

One final point. Divergence between regions and our client expectations has made it even clearer for us that we should be transparent with our clients, which remains our key priority. This is how we can fulfil our role as a manager of our clients’ money, including in the ESG space.

Please note: Environmental, Social and Governance (ESG) or sustainable investing considers factors beyond traditional financial analysis. This may limit available investments and cause performance and exposures to differ from, and potentially be more concentrated in certain areas than, the broader market.