Incomplete ESG data in fixed-income investing: Challenge and opportunity

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      By Brian S. Ellis, CFACalvert Fixed Income Portfolio Manager and Vishal Khanduja, CFADirector of Investment Grade Fixed-Income Portfolio Management and Trading, Calvert Research and Management

      Boston - Quantitative studies have illustrated the benefits of embedding ESG factors into an investment process when looking at long-term, risk-adjusted returns.1,2 As these studies shift focus from public equities to other asset classes, including fixed income, we expect the findings will continue to show similarly beneficial results.

      We have long argued that an issuer's fundamental quality cannot be completely considered without understanding how it is managing its financially materal ESG risks and opportunities. In the equity space, investors often find a correlation between quality ESG companies and fundamental quality.

      In active, multisector fixed-income strategies, however, managers typically do not limit their opportunity set to issues of the highest credit quality. That's because such issues generally have relatively tight credit spreads that can limit total return potential.

      The quality challenge

      For a manager seeking to integrate ESG factors, this poses a dilemma: Public ESG data supplied by vendors is most readily available for the highly rated credits included in the benchmark. Issues with lower credit ratings often have good ESG scores, undisclosed to the public, along with attractive spreads. But, those issuers often exhibit some combination of weaker credit metrics, higher leverage and underlying fundamental challenges.

      A deeper data dive

      Much of the publicly available ESG data is inconsistent and incomplete. Calvert's methodology incorporates proprietary ESG information sources and research, so we can vet and expand upon public sources as necessary, and maintain a consistent framework for analysis. Thus, we view the fragmented nature of ESG information as a potential alpha source — a way not just to help mitigate risk, but to identify opportunities. Most importantly, however, is the resulting opportunity set, which is broader and includes issuers of all sizes and credit qualities, including non-public issuers.


      Maturity and capital structure

      Fixed-income investing inherently offers different ways to invest in a particular issuer. Investors can choose from various maturities and parts of the capital structure depending on outlook, risk tolerance and valuation. An issuer's ESG performance at times may be material enough to affect our fundmantal view and our maturity and capital structure decisions.

      Consider a company that is striving to address its long-term carbon transition risks, and may merit longer-term, longer-duration investment. But it may also have deteriorating governance — something that might warrant limiting exposure to shorter-term or more senior debt. The ability to implement investment decisions closely aligned with our conviction levels, based on material ESG information, is a significant advantage to our process.

      Bottom line: In active, multi-sector fixed-income strategies, like Calvert's, we believe it may be necessary to look beyond benchmark positions to maximize performance. Calvert's particular combination of ESG focus, philosophy, resources and experience allows us to review the broadest possible range of issues across credit and ESG metrics.