Stewardship in fixed income: the power of investor engagement

Join Fionna Ross, Kate McGrath and Nicole Lim as they discuss the power of investor engagement in fixed income. 

Transcript

Fionna Ross

Hello, I'm Fionna Ross. You're listening to the abrdn podcast, Sustainability Inspires, discussing all things relating to sustainability and responsible investing. 

Today we're bringing you the second of abrdn podcasts focused on abrdn Investments approach to engagement. 

In the first of the series, Nick Robinson from the Emerging Markets Equities Podcast invited Senior Investment Director in the Asian Equities team, David Smith, to discuss the role shareholders can play in helping companies on their journey to net zero.

Now I'm delighted to have with me on the podcast Kate McGrath. 

Kate McGrath

Hi, Fionna. Thanks for having me. 

Fionna Ross

Hi Kate, and I've also got Nicole Lim. 

Nicole Lim

Thanks, Fionna. Great to be here. 

Fionna Ross

Great to have you. Nicole and Kate are ESG investment managers in the abrdn Investments Fixed Income team.

Today we'll be continuing the discussion of abrdn Investments approach to engagement, focusing on the guiding principles and going into detail on how the Fixed Income team aim to achieve their goals in their three-year engagement roadmap.

Now I've worked in both abrdn centralised Sustainable Investment team as well as on the Equities Investment Desk over the years, I've seen engagement in action. 

But Kate, Nicole, perhaps you could start by talking about how the Fixed Income team fit into abrdn's overall engagement strategy.

Kate McGrath

Sure. So, at abrdn Investments, engagement is all about the financial materiality of ESG risks and opportunities.

It's not just about immediate financial implications. It's about understanding how these issues can create and protect long-term value for our clients and stakeholders, including the broader economy, environment and society at large. 

What's more is that collaboration is at the core of their strategy. So, when we meet with our investments, we don't meet as Kate from Fixed Income or Fionna from Equities.

We actually meet our investments as abrdn. So, our interactions are focused, unified and that any asks of them are clear. 

So, by working together, all asset classes can use conclusions from any engagement to inform their investment decisions. 

Fionna Ross

Thanks for that, Kate. Can you talk us through a bit more on how you do that exactly? 

Nicole Lim

Maybe I'll jump in here, Fionna. 

So, at abrdn, each asset class have what we call on-desk ESG Analysts such as myself and Kate within Fixed Income. 

Our on-desk fixed income ESG team drive the research and engagement priorities for the broader Fixed Income team, such as the themes that will be outlined in our Fixed Income Engagement Roadmap. 

Then, to unify our individual asset class efforts and support our broader engagement priorities, we have a dedicated Active Ownership team, within our Sustainable Investment Team.

These colleagues bring specialised stewardship, effectively bridging the gap between different asset classes. 

Fionna Ross

Now, when it comes to company engagement, most people automatically think of equities, and there seems to be a common misconception that the power to engage is actually only within equity. 

So why engage as a fixed income investor? You know, what role can fixed income investors actually have in engaging with issuers?  And do you think that they can actually really make a difference?

Kate McGrath

So, this is a question that clients always ask when we start talking about fixed income engagement. 

Unlike buying shares where equity holders can vote on company decisions. Buying bonds doesn't give you that ability. 

And this is really why we are due to publish our engagement roadmap.  To provide transparency to our clients and investee companies on the topics that we will be engaging on within the next three years.

Nicole Lim

And to just to add on to what Kate has mentioned, we'd always like to say capital structure is as important.  As abrdn and as a global firm that manage investments across asset classes globally, we have the ability to engage with companies across the capital structure. 

And as Kate mentioned, this gathers insights into the key ESG drivers for stock owners, bond holders or both.

While equity markets receive considerable attention given again, the focus on voting. It is worth highlighting that majority of primary market financing occurs within the debt markets. 

So, in this respect, fixed income investors maintain a direct interface with companies actively seeking capital.

Beyond publicly traded companies fixed income investors engage with a diverse range of non-listed issuers. These include private entities, government municipalities, state owned enterprises, infrastructure projects, housing associations, and so on.

I would like to point out also that a significant part of the fixed income universe includes issuers and entities that are the foundation for the energy transition and sustainable development more broadly.

We're talking about public utilities, railways, grids and core infrastructure. So, when we engage with such non-listed issuers, it is often the first time, they have discussed ESG topics with an external stakeholder.

So, our impact on these issues can sometimes, in many respects be more influential than with large publicly listed companies. 

Fionna Ross

Do you have any examples of this that you could share just to help bring that that more to life? 

Kate McGrath

I'll jump in here. So actually, to Nicole’s point, we find that non-listed issuers are way more responsive to our asks of them.

And we actually once met with a small, unlisted UK issuer in the social housing sector, and we raised with them the lack of board diversity as a concern, particularly because this was not representative of the communities that they serve. 

Off the back of this, the Finance Director actually invited us to a board meeting to co-create a diversity and inclusion strategy.

And since then, the board has actually hired two new female board members. 

Fionna Ross

That's fantastic. Sounds like you're having some great, you know, really constructive engagements there. 

It would be good to understand a bit more, though, on how you can sustain some of these engagements through fixed income. 

Nicole Lim

Yeah, so, we like to think of engagement with bond issuers as engagement across a bond's lifecycle.  So, engaging pre issuance and post issuance.

For engaging pre issuance, one relatively straightforward way that fixed income investors engage is through roadshows or meeting with issuers at the point they come to market, or when they intend to issue at some point near the future. 

We find that companies are often very receptive and very open to engaging at this time.

It is at this time also that fixed income investors have the ability to shape sustainability strategy, or simply the perception that management have with regards to tying sustainability strategy with the company's financing strategy. 

This is when we can engage both for insight and for change.  When companies interact with investors to raise financing from the bond market it is a good time for us to engage to assess the quality of an issuer’s ESG strategy and also an opportune time to raise any suggestions and expectations on how a company can potentially improve.  

Fionna Ross

Okay, great. And I'm going to ask again, do you have an example of how you engage issuers pre issuance that you could share with us?

Kate McGrath

Yeah definitely. So as a specialist Fixed Income ESG team, we are often approached by outside banks that are structuring an ESG label bond on behalf of an issuer. 

And this is great because then we can encourage the issuer itself to bring a really high-quality labelled bond to the market. For example, we might be asked our opinion on the use of proceeds for an upcoming green issue, but there's really no one size fits all approach here.

And we really have to consider the region that the issuer operates in and some projects, for example, might not align to the EU taxonomy but be considered as very ambitious in emerging market context. 

Nicole Lim

Yeah, and I'd like to echo that the points that Kate just made and I'd like to emphasise that in Asia and in emerging markets, such investor dialog, with the sell side and also with issuers is particularly helpful for developing the credibility and quality of the market as a whole from an ESG perspective.

So, issuers are often afraid of greenwashing. So, understanding investor expectations, especially on new developing areas such as the energy transition, is particularly helpful. 

Fionna Ross

So, can you help me understand? After a company issued a bond, how do you ensure that that momentum isn't lost? 

Kate McGrath

Yeah, that's a great question. And we really have to focus our ongoing engagement efforts on setting time bound milestones.

So, a milestone is basically a target that we communicate to an issuer to support the company on their ESG journey.  

For example, to set a 2030 interim carbon target to support a net zero 2050 goal, or to implement an equitable pay policy across all regions that they operate. 

What's important is that this milestone is an additional ask from abrdn.  It's not something that the issuer was already committed to. And once this milestone is set, our work doesn't stop. 

We have what we like to call a life cycle approach to engagement. And this really means that we check in on the progress towards these milestones via engagement with the issuer over an appropriate amount of time, depending on the ask.

So sometimes milestones are achieved in weeks, or sometimes this could be several years. 

So, an example of a multi-year engagement would be with a leading European utility company. And we've engaged with them since 2021. 

Now this company is a well-established climate leader, and they're making significant progress on their carbon neutral by 2030 goal.

Therefore, when they published an ambitious biodiversity goal of net positive impact by 2030, we actually really challenged them on this because back in 2021, when this was set, they didn't actually have a biodiversity policy, a strategy, or any metrics associated with this goal.

So as investors, we had no idea how they were planning on achieving this target. We set with them a series of milestones, and encouragingly, they've shown consistent progress towards these. 

So, in 2022, they released a comprehensive biodiversity policy. And in 2024, they have now identified two key biodiversity metrics to monitor their advancement towards the net positive impact on biodiversity by 2030 goal. 

Fionna Ross

Great, it's fantastic to see engagement and action kind of yielding some good results. But what about Asia? How is setting and communicating milestones different or is it the same? 

Nicole Lim

Yeah, I often get asked this question and the response that I usually give is that much of what determines success in ESG engagement across any geography is about developing relationships with the investee companies and your management through setting milestones, as Kate has mentioned.

And effectively communicating them, companies can better align to investor expectations around sustainability and ESG. 

Another misconception that many have with ESG engagements is that also, investors with the largest ownership often have the biggest say or the most attention. We have found that while there's some truth to this, this is not always the case. 

So, to your question, Fionna, many companies, especially those in Asia or in emerging markets, are early to sustainability and often more receptive to constructive input.

So, if we come as investors to provide valuable feedback that is appropriate to where they are in their journey, companies often times appreciate that a whole lot more. 

This is again where milestones serve as a great tool for investors to hold companies to account and to also support them along their journey. 

This is particularly relevant for multi-year themes such as the energy transition and making sure we're navigating a just transition. 

So, to illustrate this with another fantastic example, let me, share with you a successful engagement program with a company we have in Asia. 

We began engaging with an Indonesian telco company in 2019. When we initially engaged with them back then, the company did not have an ESG strategy in place nor disclosure. 

We met with them, and we communicated with them key milestones such as improving governance, and improving diversity within their board and crucially, also disclosing the ESG disclosures that are most material to the business. 

Shortly after, in March 2020, the company published their first sustainability report. Following a few series of engagements after that, the company has significantly improved their ESG management, meeting many of the milestones that we've set out.

These improvements have also been noted by external rating agencies, and impressively, they were updated four notches since our first engagement with them in 2019.

Fionna Ross

So, the Fixed Income Engagement Roadmap talks about a number of themes. Why is it important to highlight these emerging themes for your engagement strategy? 

Kate McGrath

So, in our Fixed Income Engagement Roadmap, we highlight four key themes that we believe are crucial for us to engage on during the next three years.

In terms of us gaining insight and also to set milestones with their issuers.  Let's clarify that while these themes are at the forefront of our strategy, they don't encompass the entirety of our engagement efforts. 

We do maintain ongoing dialogs on a variety of topics out with the roadmap, always focusing on the most material ESG risks and opportunities unique to each issuer. 

Our four themes for the roadmap are corporate governance, decarbonisation, biodiversity and labour.

And it's important to note that not all of these themes are emerging or even new to us at abrdn. 

But what is new about this roadmap is our unified, strategic approach to engagement alongside increased transparency for clients. 

We are committed to reporting on these engagements, the milestones set and achieved, and how these insights have influenced our investment decisions.

But this roadmap, we don't see it as just a glossy document for clients. 

For the Fixed Income team, this roadmap sets a definitive path towards meaningful engagement, insights and outcomes that will impact our investment decisions. 

Fionna Ross

Could you give us a quick overview of some of these themes, and how is it relevant for fixed income investments? 

Nicole Lim

Sure. So as Kate highlighted, the first and one of the core areas we engage on is corporate governance.

We believe that good corporate governance is the cornerstone for fixed income investors seeking high quality issuers. 

Engagement with company management on governance helps us understand an issuer’s commitment to responsible practices, ethical conduct, and a strategic approach to risk management, all of which are crucial elements for sustained bond performance. 

To give you some stats, a Moody's report published in 2023 notes that governance is cited as the key driver in over 80% of rating action announcements that highlight ESG factors as a consideration.

So corporate governance is a key engagement focus due to its influence on rating action, creditworthiness and cost of capital. 

Another theme in the Fixed Income Engagement Roadmap is of course, net zero and the energy transition. This is a mammoth, multi-decade investment theme that will be observed across all regions and sectors.

The energy transition is estimated to cost $9.2 trillion annually, and much of this spending is expected to be funded by debt and bond issuance, which is why it's crucial for fixed income investors to remain engaged on this topic into the future. 

As part of the net zero focus, we believe it is also essential to recognise the physical climate risks that are becoming increasingly financially material to our investments.

While climate resilience and adaptation will be needed everywhere, the negative impacts will most keenly be felt within the most vulnerable economies within the emerging markets in localised and nuanced ways. 

Again, because the fixed income universe includes issuers like governments, municipals, utilities and infrastructure in general, engaging on climate resilience as it evolves over time allows us to be holistic and forward looking in evaluating the broader net zero landscape.

Kate McGrath

Thanks, Nicole. I'll just outline the remaining two themes. 

So, biodiversity has gained a lot of attention recently, and there is increasing awareness of the role that biodiversity plays in regulating ecosystems, storing carbon and in climate change adaptation. 

But what's more is that the products or services that biodiverse ecosystems provide underpin the productivity of the economy. 

In Europe, I'm seeing increasing pressure for companies to comply with the incoming EU deforestation regulation.

So, engagement on this topic will allow us to have constructive conversations with these issuers that have exposure to deforestation risk commodities, so that we can identify winners and losers for our portfolios. 

The fourth and final theme is labour. Now, since the Covid 19 pandemic, we have all seen the structural shifts in the labour market with hybrid working, increased unionisation and strike action alongside wage inflation.

Now, just as we thought we were adapting to this new normal along came AI, which will fundamentally change the way we work in all sectors. There are additional complexities when we add in the just transition lens. 

This considers the need to upskill staff to ensure that they have the skills necessary for the green economy. 

So, what we're interested in as investors is how companies are balancing keeping staff happy to retain and attract top talent, whilst maintaining a healthy balance sheet.

So, to wrap up on these four themes, as we know these are huge topic that we have barely scratched the surface of, and there's much more detail on all of these within our roadmap, which we are super excited for the audience to read. 

Fionna Ross

Fantastic. Thanks very much, Kate, Nicole. And as you say, it really feels that we've barely scratched the surface and I have so many more questions, but I think that's all that we have time for today.

So, thanks again to Kate and Nicole for joining us today. 

Nicole Lim

Thanks, Fionna, for having us. 

Kate McGrath

Thank you. 

Fionna Ross

All that remains is for me to thank all those who have taken the time to tune in. If you liked this episode, hit the like and subscribe buttons. 

You can find us on Spotify, Apple and the abrdn website. 

Thanks again and goodbye for now.

Disclaimer

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered a is an offer investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. 

The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of abrdn. The companies discussed in this podcast have been selected for illustrative purposes only ought to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. 

The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. 

Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.