Rising yields mean that more schemes are allocating to debt, creating additional opportunities for engagement on environmental, social and governance (ESG) issues. Moreover, issuers are more concerned about their cost of capital compared to when quantitative easing provided cheap refinancing opportunities.
With high interest rates only continuing to push up demand for fixed income assets, Thomas Coudert, Head of Sustainability, Core Investments at AXA Investment Managers, says it is a vital time for pension schemes to challenge managers on their engagement activities, to ensure they are taking full advantage of the unique characteristics that give fixed income investors additional opportunities to push for more sustainable policies.
“Engagement is very important as it helps assess risk”, Coudert said. “Many companies are exposed to risks raised by climate change, be it resource scarcity, supply chain disruption or shifts in consumer behaviour. Similarly, wider ESG factors could have just as much financial impact on portfolios, depending on the sector considered. Successful engagement with issuers can help to address these risks before they become existential.”
But effective engagement requires a systematic approach. Below, Coudert sets out five key questions that will enable pension schemes to assess the strength of a manager’s engagement:
How are you focussing on my scheme’s priority areas?
“Engagement requires investors to be focused and not just react to the news flow or what seems important on a particular day. Managers should be aiming to prioritise engagement activity based on the most relevant themes, the issuers they are invested in, and the likely impact that engagement might have on those, as well as the areas most relevant for a pension scheme’s specific sustainability goals.
“At AXA IM, we engage on each goal where we think it will be most effective. For example, a 10% allocation to the utilities sector can represent over 50% of a portfolio’s carbon emissions. Therefore, these companies are likely to be at the forefront of our engagement priority list if they are falling behind on their climate policies when we are engaging on carbon emissions.”
What form is engagement taking?
“There are different methods through which to engage. The first is the most intensive and direct engagement – active engagement with an issuer in the portfolio based on clearly defined outcomes and often working to a timeline for completion of those goals.
“Collaborative engagement entails cooperation with other investors to help amplify the message; this includes things like participation in initiatives such as the International Capital Markets Association Green Bonds Principles and Climate Action 100+.
These collaborative initiatives are crucial in driving change through harnessing the power of an entire industry, which is why we remain strongly committed to our participation in them.”
“Finally, a sustainability dialogue is regular communication with issuers to understand how they are approaching topics covered by our engagement themes and to build good relationships; from day-to-day conversations to more formal direct engagements. We believe it is important for asset managers to split out these types of engagement to give proper transparency to the intensity levels of the engagement activities undertaken.
“Ideally you want your manager to be using a blend of these methods with any particular issuer when trying to create change.
Outside of engagements with the issuers themselves, liaising with counterparty banks, data providers and policy makers all help to positively shape the frameworks through which fixed income markets operate.”
How are you tracking engagements?
“It’s important to track engagement along a set path. Ask your manager how many engagements they are taking part in, as well as clarity on when they have achieved their goals and the planned course of action if the engagement isn’t progressing.
“As a rule of thumb, you should expect it to take between 12 to 36 months for an engagement to play out. This leaves time to persuade the company of what you want to achieve and for the company to respond.”
What’s the escalation protocol?
“As engagements progress, particularly where there is a fixed objective, there will be times a manager should be increasing their efforts to secure a positive outcome by escalating their efforts if they feel the engagement is not going where they want it to go. For example, engaging higher up the corporate hierarchy or coordinating with other investors. At AXA IM, we always seek to use our voting rights as part of the escalation options when managing fixed income.
“Ultimately, if an issuer is unwilling or unable to change direction, there is the option of divesting. When an investor divests, they lose the opportunity to encourage positive change, so this should really be seen as a last resort. Make sure you know your manager’s stance on this.”
How are you measuring success?
“We believe asset managers need to regularly report on engagement activity to their clients as stewards of their investments. Many managers provide engagement reports which provide valuable insights into their overall engagement activity, but it’s also important to ensure that your manager is including portfolio-specific metrics on the engagement undertaken and where various engagement initiatives are.
“For its part, AXA IM recently expanded portfolio-level engagement reports and now reports on over 30 different engagement metrics. We also provide quarterly qualitative engagement examples to our clients, so they have clarity on action being taken on their behalf.”
Coudert concluded: “Pension schemes have a key role to play in making a better world through their fixed income allocations. Engagement undertaken by their managers is a vital part of this. As guardians of capital, the asset management community is a vital medium whereby we can represent schemes’ interests to the issuers we invest in on their behalf to help create a more sustainable world for the benefit of their members.”
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