Fixed income investing giant PIMCO has embedded ESG at the heart of its investment processes – and sees engagement as central to improving issuers' sustainability performance. Scott Mather, CIO of PIMCO's US Core Strategies, explains the firm's approach.
Environmental Finance: What's PIMCO's starting point when it comes to addressing ESG issues in general, and climate change in particular, in your approach to investment?
Scott Mather: It is critical to analyse ESG issues in terms of risks and opportunities for everything we invest in. We now have standalone ESG scores for almost every issuer,
and it is increasingly important to factor those scores into investment analysis.While it's generally appreciated that
governance has always been very important for investment performance, there's a growing appreciation that the pace of change with respect to environmental and social issues presents more risks and opportunities. Climate, in particular, poses an existential threat to almost every business model and to society in general. All the evidence points to it being a critical problem, but it can be a critical element of the recovery on the other side of the current crisis as well. We are seeing policymakers and others looking at ways to build back to better address climate
issues. That's just one example of how society responding to an ESG issue creates tremendous opportunities and, of course, tremendous risk for those that don't address it properly.
EF: How does your approach to ESG differ between your conventional funds and portfolios and dedicated ESG products?
SM: We think ESG factors are critical to optimising risk-adjusted returns, including in portfolios that aren't especially focused on sustainability. But in our ESG-labelled funds,
and our thematic funds such as our climate strategy, we elevate the level of importance we attribute to ESG factors and we also dedicate ourselves to a higher level of engagement with the issuers in those portfolios. That means that we try to identify those companies that we can interact with and help on their journey, working together with them to really have an impact.
EF: PIMCO actively engages with issuers on ESG issues – what approach you take?
For the most part, our engagement is collaborative. There are times when we do exclude companies because of their unwillingness to engage with their lack of progress with respect to addressing ESG issues. But our philosophy is that large investors, asset owners and asset managers like ourselves can really help move the needle by engaging in a collaborative way with issuers, helping them understand where they stand relative to their peer group, or where there are innovations they're not seeing yet, but which are applicable
to their business. We have access to more data and information, and we can play a role by engaging and keeping issuers informed. We also collaborate with key industry groups.
For example, we are members of the Climate Action 100+ initiative, which is engaging with the world's largest corporate emitters to encourage them to address climate change.
EF: How is ESG engagement in fixed income different to that pursued by equity investors?
SM: Fixed income is an ideal asset class to drive
change. The bond market globally is twice the size of the equity markets and, while shares – in theory – exist in perpetuity once issued, bonds mature and companies need to refinance. This process is unique to fixed income and gives us a powerful way of connecting, allowing us to push for sustainability commitments and accelerate change. In equities, there's no need
to engage in the same way. There are, of course, differences between the two asset classes. Equity investors tend to be more focused on the growth opportunity, while fixed income investors are more focused on risks that can impact the repayment of debt or which may affect company business models.
Also, there is a widely held view that equity investors – as owners – have more influence than bond investors. But equities and fixed income are more
the same than different: there's almost always alignment when it comes to engagement on ESG issues. And we have certainly found that issuers care a lot more about ESG than many
investors may realise. They recognise that ESG risks are increasingly incorporated into agency credit ratings, which can dramatically affect the cost of servicing their debt.
EF: PIMCO was awarded Environmental Finance's ESG investment of the year award (fixed income) for your recently launched Climate Bond Strategy. What's the approach behind the strategy?
SM: The Climate Bond Strategy is a multisector credit portfolio to allow investors to specifically allocate capital to bonds addressing the climate action theme, offering riskadjusted returns comparable to an investmentgrade credit portfolio, allied, of course, with extremely low carbon intensity.
It is built on three pillars – labelled green bonds, unlabelled green bonds, and the bonds of issuers demonstrating innovative approaches to environmental sustainability.
Green bonds are those whose proceeds are directed towards a specific green project or purpose. Unlabelled green bonds are debt securities of issuers who are materially exposed
to climate solutions, such as a solar company or rail company, rather than bonds linked to an explicit green project. But the strategy also invests in the debt of companies that are not producing explicit climate solutions, but which we consider to be 'climate leaders' – issuers at the forefront of the net-zero transition. They have demonstrated a strong commitment to mitigating carbon emissions and their broader environmental footprint and they are exploring innovative ways to integrate sustainability across their entire value chain.
Examples include real estate investment trusts with leading environmental strategies and food companies committed to ending deforestation and to sustainably sourcing
their products.
Opening the strategy to those types of issuers gives us a wider opportunity set in which to invest, increasing the strategy's diversification and reducing the risk it takes.
EF: Has the Covid pandemic changed the focus on climate change by issuers and investors? What are the implications?
SM: There's no doubt that the pandemic and the economic impacts of lockdowns are a setback for efforts to address climate change, but we believe this setback will be short term in nature. We have seen some very positive signals from governments in parts of the world, notably Europe, that climate action should be a fundamental component of postCovid recovery packages.
More broadly, Covid is acting to underline the importance of ESG issues to public policy and corporate performance. The pandemic has its roots in failures in food safety and animal welfare, and it has shone a spotlight on social inequality around the world. It is clear to us that the current crises will only sharpen the focus on how businesses interact with all of their stakeholders, and we expect companies to be more transparent regarding the social aspects of their business.
While lockdowns around the world may have temporarily reduced greenhouse gas emissions, climate change remains an urgent challenge. As the impacts of extreme weather events and rising sea levels increasingly make themselves felt, climate change risks becoming like a pandemic every year. If we don't address it, it will not go away.
EF: What about how investors are approaching the SDGs – has Covid led to a rethink about how you prioritise delivering impact against the SDGs?
SM: The UN Sustainable Development Goals provide a global sustainability language. Measuring the impact of investments and related engagement efforts is critical, and the
language that the SDGs create help us to quantify those impacts.
Green bond reporting is now aligned with the SDGs and we see this as a growing trend. The SDGs have been broadly embraced by leading companies and responsible investors,
but there is limited awareness of them among consumers. Once that starts to change, we would expect even more uptake in the
corporate world.
It's also an area where we are working directly to help companies deliver against the SDGs. I'm co-chairing the UN Global Compact CFO Taskforce for the SDGs, a two-year project established in partnership with the UN Global Compact and energy utility ENEL. The taskforce aims to mobilise hundreds of CFOs to tackle the financing needs around the SDGs.
EF: The pandemic has prompted a number of sovereign and corporate issuers to come to market with Coronabonds.
How does PIMCO assess the attractiveness (or otherwise) of such issuers?
SM: Coronabonds are a great example of innovation within the use-of-proceeds market, and of how issuers are embracing that innovation. Some of these issues are better than others, but broadly speaking we welcome the development of this part of the market, although we recognise that it is likely to be relatively short-lived.
What we like to see from issuers is a clear explanation of how the proceeds from these bonds can be used to make them more resilient in the face of longer-term sustainability
challenges – for example, how they are helping them respond to the SDGs. Linking to the SDGs makes these bonds a less niche solution by creating a broader asset class. It is vital that issuers continue to innovate, while not thinking too narrowly, to ensure they are well positioned to address the sustainability challenges of thefuture.