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Economic and Market Commentary

Key Takeaways From PIMCO’s Sustainable Investing Report 2023

PIMCO’s Sustainable Investing Report provides our latest thinking on sustainability. Here, we highlight the report's key takeaways on engagement, energy transition and carbon analytics.

The sustainable investing landscape is being transformed by several long-term drivers, from evolving global regulation that will continue to have investment implications, to dominant trends like climate transition risks and the unlocking of capital flows to underserved markets. We are also witnessing a compelling convergence of emerging themes – such as nature and biodiversity, climate physical risks, and access to affordable housing. These shifts are creating steadfast investment opportunities such as thematic labeled bonds, transition finance, and private credit strategies, and we are excited by these and other possibilities we see emerging over the secular horizon.

This year PIMCO has focused on expanding our robust platform, deepening our analytical capabilities and diversifying our proprietary frameworks. Consistent with our broader investment platform, our efforts extend beyond traditional areas of fixed income and into alternative asset classes, including private credit, structured products, and real estate. Additionally, we have strengthened our in-depth climate risk and biodiversity analysis, including additional carbon analytics, carbon attribution and projection tools.

All of this we do with our clients in mind. We are committed to helping clients pursue their investing goals and actively engage with them to implement thoughtful solutions that aim to deliver on their objectives.

PIMCO’s “Sustainable Investing Report” offers detailed insights on these developments, along with our latest thinking on market drivers and trends, and detailed case studies on engagement. Here are some highlights from the report.

Environmental and climate research

In 2023, the transition to a lower-carbon economy was marked by both progress and challenges. For example, the renewable energy sector, including offshore wind, faced issues such as high initial valuations, execution problems, supply chain disruptions, and increased funding costs driven by increasing interest rates. Despite these difficulties, the general commitment to green technologies and climate investment remains strong, bolstered by international and regional policy developments.

The transition is unrolling at varying paces across different regions, and there is no one-size-fits-all interpretation and implementation of climate transition plans for an issuer or investor. This is in part why we continuously look at ways to enhance and expand our capabilities to assess and manage climate risks, as well as measure and optimize the climate impacts of portfolios. For example, we have deepened our research on topics like Scope 3 (i.e., upstream and downstream) carbon emissions, carbon reporting outside corporates (e.g., sovereign and securitized products) and climate solutions. The goal is to ensure our frameworks and tools reflect market developments and client needs; and in 2023, the focus broadly shifted among many asset owners from setting portfolio climate targets to implementing them at the portfolio level.

We have developed a proprietary portfolio carbon projection tool to analyze transition risks and decarbonization targets. This tool estimates potential future carbon emissions associated with a portfolio based on various scenarios specifically relevant for fixed income. It considers factors like reinvestments and issuer commitments or their historical emissions. The reinvestment of matured securities, for example, can significantly impact the rate of decarbonization for a portfolio and, if well handled, may create an opportunity to advance a portfolio’s carbon targets while supporting real-economy emissions reductions.

Structured credit and real estate integration

We believe PIMCO’s scale and experience across a range of markets make us well positioned to play a vital role in strategic industry efforts related to sustainable investing. This extends beyond corporate entities, into structured credit, as well as sovereigns, municipals, and alternatives, where applicable. These multifaceted efforts provide a distinctive market perspective that is unique to PIMCO.

Structured products are significant in the fixed income market, making up about 25% of all outstanding securities. PIMCO considers them an essential investment component in supporting clients in their sustainability journeys. They have unique advantages as well as downsides, but the variety within the asset class has allowed our clients to explore investment opportunities that offer either environmental or social benefits.

Over the last year we have continued the development of our proprietary frameworks across multiple asset classes and themes, including expanded Environmental, Social and Governance (ESG) scoring coverage and analysis of structured products including auto-asset backed securities (ABS), collateralized loan obligations (CLO), covered bonds, sovereigns, supranationals, and agencies (SSA).

We also continued building out our real estate platform in 2023. PIMCO invests in a variety of real assets including commercial, residential, and infrastructure investments. In addition to the overarching materiality framework which underpins our alternatives approach, we have developed specific and proprietary tools for broadly assessing material risks which can arise from investing in real assets. This framework includes specialized research and analysis related to physical and transition climate risks, energy usage and efficiency, as well as affordability and access.

Labeled bonds and role of fixed income in sustainable investing

Despite a decrease in absolute issuance of ESG-labeled bonds in 2022 and 2023, the proportion of ESG labels within corporate fixed income indices continues to grow, partly due to a higher rate of traditional bonds exiting these indices. PIMCO applies its fixed income expertise to this area, using tools such as our proprietary relative value tracker to assess the "greenium" or the discount/premium of ESG-labeled bonds compared to traditional bonds.

Recognizing the importance of sustainability-linked bonds (SLB) within the ESG labeled bond universe, we have developed a proprietary SLB tracker. This tool assesses bonds with upcoming Key Performance Indicator (KPI) testing dates on a periodic basis. It is critical for portfolio managers, as a growing portion of outstanding SLBs approach milestones for their sustainability KPIs, potentially triggering coupon step-ups.

However, ESG bonds are only one part of the ESG-investible universe, as many issuers with favorable ESG profiles continue to issue traditional debt, and we will continue to maintain a balanced focus on communication and research for conventional bond investments.

We believe bond investors can play a pivotal role in the sustainable transition of economies and businesses; and we seek to execute our strategies through research, engagement and investment, leveraging the multiple connections between capital providers and issuers. We employ a forward looking, integrated approach to pursue long-term value for our clients.

Download our Sustainable Investing Report here to read more of our views and analysis, as well as our engagement case studies. Visit here to learn more about sustainability at PIMCO.

Disclosures

Environmental (“E”) factors can include matters such as climate change, pollution, waste, and how an issuer protects and/or conserves natural resources. Social (“S”) factors can include how an issuer manages its relationships with individuals, such as its employees, stakeholders, customers and its community. Governance (“G”) factors can include how an issuer operates, such as its leadership, pay and incentive structures, internal controls, and the rights of equity and debt holders.

Sustainable Strategies are strategies with client-driven sustainability requirements. For these strategies, PIMCO actively incorporates sustainability principles (i.e. excluding issuers fundamentally misaligned with sustainability factors, evaluating issuers using proprietary and independent ESG scoring) consistent with those strategies and guidelines. Further information is available in PIMCO’s Sustainable Investment Policy Statement. For information about funds that follow sustainability strategies and guidelines, please refer to the fund’s prospectus for more detailed information related to its investment objectives, investment strategies, and approach to sustainable investment.

Green Bonds: are a type of bond whose proceeds are used to finance or re-finance new and existing projects or activities with positive environmental impact. Eligible project categories include: renewable energy, energy efficiency, clean transportation, green buildings, wastewater management and climate change adaptation. Social Bonds: are a type of bond whose proceeds are used to finance or re-finance social projects or activities that aim to address or mitigate a specific social issue or seek to achieve positive social outcomes. Social project categories include providing and/or promoting: affordable basic infrastructure, access to essential services, affordable housing, employment generation, food security, or socioeconomic advancement and empowerment. Sustainability Bonds: are a type of bond whose proceeds are used to finance or re-finance a combination of green and social projects or activities. Sustainability bonds with strict accountability of the use of proceeds towards activities that advance the UN Sustainable Development Goals or SDGs may be labeled as SDG Bonds. Sustainability-linked Bonds: are bonds which are structurally linked to the issuer’s achievement of certain sustainability goals, such as through a covenant linking the coupon of a bond to specific environmental and/or social goals. Progress, or lack thereof, toward the aforementioned goals or selected key performance indicators results in a decrease or increase in the instrument’s coupon. In contrast to the green, social and sustainability bonds described above, sustainability-linked bonds do not finance particular projects but rather finance the general functioning of an issuer that has explicit sustainability targets that are linked to the financing conditions of the bond.

There is no assurance that the socially responsible investing strategy and techniques employed will be successful.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. Investors should consult their investment professional prior to making an investment decision.

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the markets perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Structured products such as Collateralized Debt Obligations (CDOs), Constant Proportion Portfolio Insurance (CPPI), and Constant Proportion Debt Obligations (CPDOs) are complex instruments, typically involving a high degree of risk and intended for qualified investors only. Use of these instruments may involve derivative instruments that could lose more than the principal amount invested. The market value may also be affected by changes in economic, financial, and political environment (including, but not limited to spot and forward interest and exchange rates), maturity, market, and the credit quality of any issuer. Diversification does not ensure against loss.  Covered bonds are generally affected by changing interest rates and credit spread; there is no guarantee that covered bonds will be free from counterparty default. Collateralized Loan Obligations (CLOs) may involve a high degree of risk and are intended for sale to qualified investors only. Investors may lose some or all of the investment and there may be periods where no cash flow distributions are received. CLOs are exposed to risks such as credit, default, liquidity, management, volatility, interest rate and credit risk. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses.  Management risk is the risk that the investment techniques and risk analyses applied by an investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy.

ESG investing is qualitative and subjective by nature, and there is no guarantee that the factors utilized by PIMCO or any judgment exercised by PIMCO will reflect the opinions of any particular investor, and the factors utilized by PIMCO may differ from the factors that any particular investor considers relevant in evaluating an issuer’s ESG practices. In evaluating an issuer, PIMCO is dependent upon information and data obtained through voluntary or third-party reporting that may be incomplete, inaccurate or unavailable, or present conflicting information and data with respect to an issuer, which in each case could cause PIMCO to incorrectly assess an issuer’s business practices with respect to its ESG practices. Socially responsible norms differ by region, and an issuer’s ESG practices or PIMCO’s assessment of an issuer’s ESG practices may change over time. There is no standardized industry definition or certification for certain ESG categories, for example “green bonds”; as such, the inclusion of securities in these statistics involves PIMCO’s subjectivity and discretion. There is no assurance that the ESG investing strategy or techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results.

This material contains the current opinions of the manager, and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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