In recent years, an increasing number of market participants have shown interest in sustainability-driven investing and have started to incorporate elements of environmental, governance, and social (ESG) factors in their investment processes. Various rationales have been given for the inclusion of these factors.
The first rationale is that from a risk/return perspective, companies that consider impact investing and ESG practices associated with their business activities are likely to be ahead of their peers. From an environmental standpoint, actively managing a portfolio’s footprint may help decrease exposure to companies that may face legal and reputational risks and provide a hedge against future regulatory changes. For example, as the world transitions to a low-carbon economy, organizations that have been proactive will be better positioned to adapt to new regulations, innovation, or a shift in consumer appetite.
The second rationale for investing in these types of companies comes from social or personal values and goals. These investors aim to create portfolios that balance financial returns within the scope of mission objectives.
No matter the rationale, there is a wide range of options for fixed income market participants to navigate. A common approach to navigating among these options has been to rely on evaluation metrics, or ratings that measure the ESG impact of companies’ operations, and overlaying the score onto assets. The main challenge of this approach is that currently there is no clear standard of measurement in the market.