Viewpoints

Sustainable Investing: PIMCO’s Environmental, Social and Governance (ESG) Initiative

As part of PIMCO’s sustainability initiative, we are creating a dedicated investment platform focused on ESG-related opportunities.

PIMCO has incorporated sustainability factors in the investment process for decades. The process emphasizes rigorous analysis of broad secular trends, which are at the core of both global sustainability and long-term asset returns. In recent years, PIMCO has developed a platform that will support ESG-focused investment solutions. In this Q&A, PIMCO’s Kwame Anochie and Alex Struc, the co-leaders of PIMCO’s sustainability initiative, discuss the evolution of environmental, social and governance investing globally and at PIMCO.

Q: Why should investors and investment managers focus on sustainability issues with their investments?
Struc:
Sustainable investing makes good business sense. It can help mitigate risks and potentially improve the return profile of an investment portfolio, and it is an intellectually engaging objective as well.

At PIMCO, we are in the business of delivering risk-adjusted returns for our clients in a manner that is sustainable over the long term. That means making sure that the investments we make on their behalf represent business models that are competitive not only today but well into the future. We complement the traditional analysis of companies’ financial statements with careful consideration of intangibles and secular trends, which when they materialize can have a profound impact on the health of balance sheets. Changing demographics is one example of a secular trend that could affect investors everywhere: As the world’s population grows in numbers and in many countries people live longer, collectively we don’t think only about securing a better future for our children; we also want a bright future for our older selves. So in many ways, sustainable investing is not just good business – it is personal, too.

Delivering sustainable returns may be challenging in the world of low growth, low interest rates and flat yield curves. In this world, investors are paid less to take more risk, and those who make more dynamic and active investment decisions may be rewarded. The markets may also reward those who focus more on ESG – the environmental (the world), social (the people) and governance (culture and conduct) factors likely to increasingly influence future returns.

Q: Are more investors focusing on sustainability? Is this a trend across the financial services industry?
Anochie:
Yes, we see that our clients (both individuals and institutions) and other important stakeholders are increasingly concerned about the implications of ESG factors and how they affect the well-being and smooth functioning of the global economy and markets. The widespread endorsement of the United Nations Principles for Responsible Investing initiative (UN PRI) is an example. The UN PRI was launched in 2006 with 32 signatories from nine countries (predominantly large public pension funds headquartered in developed markets) to contribute to the development of a more sustainable financial system. As of April 2016, the UN PRI had more than 1,500 signatories from over 50 countries managing assets in excess of $60 trillion.

Two primary drivers of this trend toward more sustainable investing are the changing demographic landscape and increased regulatory focus. Wealth managers globally are preparing for the great wealth transfer from the baby boomer generation to the millennial generation and female investors. Women are projected to control two-thirds of the world’s wealth by 2020 (according to MSCI), and millennials will increasingly become the world’s decision makers. Research also suggests that both millennials and women are increasingly looking to align their investment and financial goals with their values without diminishing their return expectations. In other words, they seek an additional unit of value beyond the financial returns.

On the regulatory front, one notable shift toward support for sustainability-focused investing was the recent change in U.S. Department of Labor (DOL) fiduciary duty rules allowing managers to incorporate ESG strategies. Fiduciary duty is the legal mandate to act in the client’s best interest when making investment decisions (e.g., focus on returns); the new DOL guidance acknowledges that ESG factors “may have a direct relationship to the economic and financial value of an investment” and thus may be “proper components of the fiduciary's analysis of the economic and financial merits of competing investment choices.” Other regulatory decisions globally, including the ongoing European Commission work to develop non-binding guidelines for companies to disclose nonfinancial information and the Financial Stability Board’s task force to develop a voluntary standard on climate-related financial disclosures for companies, are all helping.

Struc: The focus on ESG is wide-reaching. For example, the effects of climate change are now collectively acknowledged by governments, regulators, global corporations, asset owners, asset managers and the broader investment community. More investors recognize the urgency of understanding, stress-testing and hedging climate risks. Also, more people understand supply chain effects – the impact businesses have on their immediate and broader communities and potential costs associated with poor decisions. Culture and conduct are ever more important in how the financial system fulfills its mandate of facilitating sustainable economic growth.

Sustainable investing is no longer only a topic of a heated debate – we’re seeing new policy initiatives and regulatory changes underway. For example, 177 countries (including the U.S.) have adopted the climate agreement from last year’s COP21 conference in Paris. Under this agreement, governments and corporations will set targets that will trigger changes likely to affect the longevity of many different business models. It is imperative that we start early with identifying winners and diversifying away from losers. We believe companies that position themselves for the transition should be able to deliver steady performance, while for those inflexible or unwilling to change, the costs may prove severe. In this sphere, we at PIMCO are determined to protect our clients’ interests and unlock potential value through active engagement with issuers.

Q: Shifting focus to PIMCO’s approach to ESG, what is the company’s sustainability initiative?
Anochie:
PIMCO launched its sustainability initiative in 2011 with a mission “to deliver risk-adjusted returns that are consistent with our clients’ objectives, through an investment process that is designed to identify the medium to long-term dynamics associated with sound governance and the sustainable utilization of both human capital and natural resources.” While we codified that mission in 2011, it has been a natural part of our philosophy and process since the firm was founded: Our belief is that a thorough assessment of investment opportunities should include an analysis of ESG risk factors because they affect the value and the potential trajectory of the securities that we buy on behalf of our clients.

PIMCO also became a signatory to the UN PRI in 2011. The PRI provided a framework for PIMCO professionals to engage with both asset owners and managers on the challenges related to ESG integration.

Our sustainability initiative is about more than anticipating and understanding ESG dynamics as an important part of a robust investment process; sustainability is integrated into our firm’s culture in multiple ways. We consider the impact our firm and our people have on the communities that we serve, including our charitable and volunteer efforts through the PIMCO Foundation and also the LEED certification of our Newport Beach headquarters. We are also evolving our firmwide culture to promote greater diversity of identity and thought, mitigate unconscious biases and demonstrate inclusive leadership. We recognize that a more inclusive and diverse culture enables better talent and business decisions, and we believe this can in turn help support sustainable higher performance for our clients.

Struc: PIMCO’s sustainability initiative is also about bringing clarity to how environmental, social and governance issues are applied in the financial services industry. We interpret the general lack of standardization across the industry as an invitation to share our unique experiences and skills, which are based on a well-rounded investment process, strong credit research and deep understanding of supply chain effects, all informing our relentless search for the most attractive opportunities to express our investment views. We emphasize continuity, where clear communication, management of expectations and execution on commitments are key deliverables.

Our sustainability initiative is overseen by PIMCO’s Group CIO and CEO, led by Kwame and me (representing both the client facing teams and portfolio management) together with a core leadership team, and assisted by the 40-member cross-functional working group. We are collectively responsible for strategy and firmwide integration of ESG principles, and we are implementing specific deliverables that include credit research, thought leadership, building key partnerships and creating dedicated fixed income solutions for our clients.

Q: What kinds of ESG solutions do we offer investors today, and what’s next for PIMCO in ESG?
Anochie:
We focus as we always have on long-term sustainability issues, and we will continue to evaluate ESG risk factors as part of the investment process. What is new is our recently created ESG-dedicated investment platform that will support the ESG solutions we are developing to help our clients meet their goals. This new platform – we call it ESG 2.0 – combines both exclusions (investment screening) and active management with a deep focus on issuer engagement to unlock potential value. The platform will enable products that concentrate on ESG risk – that is, solutions that take sustainable investing a step beyond the general integration of ESG factors into the overall investment process, and into a complete focus on ESG-related opportunities and issuer engagement. These new ESG solutions will offer added value to our clients who are looking to make an impact with their pensions, endowments, foundations, corporate cash and other savings vehicles.

Struc: We are excited to partner with our clients in our shared endeavor to achieve their objectives through our new ESG platform, further integration of ESG into our investment process and new thought leadership. We continue to enhance our technology platform and invest in ESG research capabilities. Additionally, we are working with other like-minded investors to promote sustainability globally, and PIMCO continues to engage with the UN PRI, where we serve on the advisory and fixed income steering committees. We strongly emphasize the value of issuer engagement and believe that fixed income and equity investors alike have a voice and can influence change in addition to delivering performance.

The Author

Kwame Anochie

Account Manager, Global Wealth Management

Alex Struc

Portfolio Manager, Corporates and Financials

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