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Real assets and the net-zero pathway
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The sustainable forces driving change in real assets
The real asset green premium explained
n 2021, total issuance of ESG labelled bonds exceeded an unprecedented $1trn. This growth was driven by a number of innovations and trends, including the rise of
sustainability-linked bonds and increasing issuance of green labelled debt by sovereign issuers.
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“Net zero commitments are set to revolutionise the world of long-dated real assets”
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SUSTAINABLE FIXED INCOME
Disclaimer
Last year was a milestone for the sustainable bond market
Mark Meiklejon on the Aviva Investors’ Climate Transition Real Assets Fund
How can pension funds use ESG to futureproof portfolios?
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Featured in this Spotlight
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Ketish Pothalingam Portfolio Manager, EVP
Ketish is a member of PIMCO’s ESG team, focusing on corporate credit and global bond ESG portfolios
Samuel Mary ESG Research Analyst, SVP
Samuel focuses on the integration of ESG factors into PIMCO's portfolio management and credit research
Spotlight on: PIMCO GIS Climate Bond Fund
Driving change through engagement
Sustainability in action
Innovation in sustainable fixed income
In this exclusive Spotlight guide, we discuss these developments, as well as how effective engagement is driving impact and what effect this year’s emerging global headwinds have had on the sustainability bond market.
“The milestone indicates a momentum that has heralded new innovations and trends”
All investments contain risk and may lose value. Investing in the bond market and/or investing in bond strategies 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. Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. PIMCO is committed to the integration of Environmental, Social and Governance ("ESG") factors into our broad research process and engaging with issuers on sustainability factors and our climate change investment analysis. At PIMCO, we define ESG integration as the consistent consideration of material ESG factors into our investment research process, which may include, but are not limited to, climate change risks, diversity, inclusion and social equality, regulatory risks, human capital management, and others. Further information is available in PIMCO's Environmental, Social and Governance (ESG) Investment Policy Statement. 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 assurance that the ESG investing strategy or techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results. PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the managers and such opinions are subject to change without notice. This material has been 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. For Professional Investors Only. PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. ©2022, PIMCO Past performance is not a guarantee or a reliable indicator of future results.
This digital experience is an Incisive Works product © 2021 Incisive Business Media (IP) Limited
Disclaimer Past performance is not a guarantee or a reliable indicator of future results.The Fund will be actively managed in reference to the Bloomberg Barclays MSCI Global Green Bond Index as further outlined in the Prospectus and Key Investor Information Document. Performance and fees Past performance is not a guarantee or a reliable indicator of future results. Performance figures are presented net of management fees commissions, other expenses, and the deduction of actual investment advisory fees; but do not reflect the deduction of custodial fees. The "net of fees" performance figures above also reflect the reinvestment of earnings. All periods longer than one year are annualized. Separate account clients may elect to include PIMCO sector funds in their portfolio; sector funds may be subject to additional terms and fees. Charts Performance results for certain charts and graphs may be limited by data ranges specified on those charts and graphs; different time periods may produce different results. ESG Socially responsible investing is qualitative and subjective by nature, and there is no guarantee that the criteria utilized, or judgment exercised, by PIMCO will reflect the beliefs or values of any one particular investor. Information regarding responsible practices is obtained through voluntary or third-party reporting, which may not be accurate or complete, and PIMCO is dependent on such information to evaluate a company’s commitment to, or implementation of, responsible practices. Socially responsible norms differ by region. There is no assurance that the socially responsible investing strategy and techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results. For professional use only The services and products described in this communication are only available to professional clients as defined in the Financial Conduct Authority's Handbook. This communication is not a public offer and individual investors should not rely on this document. Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness.The services and products described in this communication are only available to professional clients as defined in the MiFiD II Directive 2014/65/EU Annex II Handbook and its implementation of local rules. This communication is not a public offer and individual investors should not rely on this document. Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) and PIMCO Europe GmbH Irish Branch (Company No. 909462) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). The Italian Branch, Irish Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; and (3) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.
ast year saw record issuances of green, social and sustainability (GSS) bonds. 2021 has been similar, reaching several new records. At the
same time, climate risk has become a key consideration to ensure stability of financial returns going forward as issuers and investors alike grapple with physical and transition risks.
We also hear about PIMCO’s award-winning GIS Climate Bond Fund and the opportunities it offers investors to support the transition to a net zero carbon economy.
Marketing Communication
This is a marketing communication, this is not a contractually binding document and its issuance is not managed under any law or regulation of the European Union. This marketing communication does not include sufficient detail to enable the recipient to make an informed investment decision. Please refer to the Prospectus of the Fund to make final investment decisions.
All investments contain risk and may lose value. Investing in the bond market and/or investing in bond strategies 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. Opinion and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. PIMCO is committed to the integration of Environmental, Social and Governance ("ESG") factors into our broad research process and engaging with issuers on sustainability factors and our climate change investment analysis. At PIMCO, we define ESG integration as the consistent consideration of material ESG factors into our investment research process, which may include, but are not limited to, climate change risks, diversity, inclusion and social equality, regulatory risks, human capital management, and others. Further information is available in PIMCO's Environmental, Social and Governance (ESG) Investment Policy Statement. 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 assurance that the ESG investing strategy or techniques employed will be successful. Past performance is not a guarantee or reliable indicator of future results. PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the managers and such opinions are subject to change without notice. This material has been 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.
The meteoric rise of sustainability bonds
Past the £1trn mark
The role of advisers in educating clients about responsible investment
SPOTLIGHT
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momentum that has heralded new innovations and trends.
here are many forces behind the rising importance of impactful environmental and social investing. The $1trn milestone, both in issuance and total volume, hit by the sustainable bond market last year indicates a broader appetite and
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“We have seen a growing number of sectors and issuers embracing sustainability-linked bonds”
Innovation in sustainable fixed income is shaping the future…and the present
The past year has seen plenty of action. From the significant traction we have witnessed in the sustainability-linked bonds and sovereign green bonds space, through to the latest economic and geopolitical headwinds, PIMCO’s Samuel Mary surveys the scene
PIMCO, one of the world’s largest active fixed income managers, has been offering investors the opportunity to accelerate their ESG initiatives for over 30 years. Since then, innovation in the market had not only broadened the opportunity for investors but strengthened the ESG commitments of issuers.
In general, there has been encouraging progress around the practice and disclosure of data. Last year, our Spotlight on fixed income and ESG highlighted the need for improvement in this area if the sustainability market was to fulfil its potential, and developments since then have provided a sense of optimism.
DISCLOSURE SPURS DEVELOPMENT
The EU Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021, aims to improve financial industry transparency and consistency on sustainable investments and associated processes, discourage misleading claims about an investment’s sustainability credentials, and encourage the integration of financially material sustainability risks into the investment process. It obliges certain financial market participants to make what can be complex sets of disclosures. It is one of several measures the EU is using to create a common framework for sustainability and to reorient capital flows, with the aim of easing the transition to a more sustainable economy.
The 'bend but not break' approach
One key recent innovation has been the increased use of sustainability-linked bonds. PIMCO has played an influential role in steering and shaping some of the guidance and industry recommendations around these novel instruments.
Unlike traditional green, social or sustainability use-of-proceeds bonds, which fund certain projects with dedicated environmental or social benefits, sustainability-linked bonds typically don’t finance particular projects. Instead, they fund the general functioning of an issuer explicitly linking sustainability objectives with financial targets.
“We have had a truly global rise in ESG regulations. The growing number of jurisdictions has enabled related-disclosure mandates with a focus on climate change”
“It’s very important to focus on the details of the securities themselves”
“We have seen a growing number of sectors and issuers embracing this concept,” says Samuel Mary, ESG research analyst at PIMCO. “We believe this is a particularly interesting innovation because it enables us to take a more holistic approach to ESG performance and fixed income.”
"These landmark debut sovereign issues clearly demonstrate that governments are now active participants in the ESG market, alongside corporates and supranational issuers," says Mary.
In terms of the private sector, there have been several positive developments following COP26, including growing interest in sustainability and a number of issuers pledging action for the first time. Mary says these pledges are not yet sufficient given the scale of the challenge and that monitoring their implementation will be key, but they are a step in the right direction.
“We are seeing clear progress already on the corporate sector and particularly investment grade,” he says, adding that generally private issuers, high-yield and emerging markets probably have the greatest distance to travel.
“We have had a truly global rise in ESG regulations. The growing number of jurisdictions has enabled related-disclosure mandates with a focus on climate change,” says Mary.
The most encouraging developments have been regulatory driven. The UK and European Union remain at the forefront of disclosure and regulations for the finance sector and the development of mechanisms to support the growth of the ESG fixed income market. The US, Canada and several jurisdictions in APAC are also potentially moving forward with climate-related disclosures.
That said, voluntary initiatives also gained momentum last year. The International Sustainability Standards Board was created as part of the International Reporting Standards (IFRS) Foundation and should lead to a global sustainability disclosure standard.
All of this is taking place in a context that is a lot different than it was at the end of last year. The COVID-19 pandemic helped to focus attention on issues like inclusive economies, safe and equitable workplaces, resilient supply chains, as well as alternative and cleaner energy. But now, new geopolitical and economic headwinds looks set to also shape the market for years to come.
NEW HEADWINDS SHAPING THE FUTURE
Elevated levels of inflation have been exacerbated by the Russia-Ukraine conflict, which has not only increased energy supply issues but also brought to the fore new ones, in agricultural commodities for example. These factors are acting in tandem with longer-standing climate risks.
“The rise of extreme weather events could in turn affect the agricultural commodity market, adding to inflationary pressure on that segment,” says Mary.
While the ongoing conflict in Ukraine has the potential to detract from progressing the climate agenda, PIMCO says that recent events will likely accelerate the energy transition in the long-term, not least because support for renewable energy will be needed to reduce dependence on imported fossil fuels from Russia in Europe and the UK.
“We see this as totally consistent with the way our credit analysts think”
But like many asset managers, over the last decade, PIMCO has been intensifying its focus on ESG issues. A decade ago, it became a signatory of the UN Principles for Responsible Investment (UN PRI) and established a dedicated ESG team. From 2017, PIMCO began launching dedicated ESG-labelled bond products and now offers a full suite, including the GIS Global Bond ESG Fund, the GIS ESG Income Fund and the GIS Climate Bond Fund.
the world of investing for several years, but the concept is not new for PIMCO. The bond house first offered clients a socially responsible version of one of its key funds as far back as 1991.
he idea of investing with environmental, social and governance (ESG) principles in mind has been gaining traction in
According to Ketish Pothalingam, portfolio manager and member of PIMCO's ESG team, today the group has ESG integrated in its investment thinking, with sustainability metrics integrated into the way teams consider risk.
“The more generic, plain vanilla assets have seen a lot of support from central banks over the past year, so the valuations of these assets are not as compelling today,” explains Murata. “You have to work harder to generate attractive returns in this environment.”
Risk assessment
The second major trend has been the growth of sovereign green bonds. A number of countries in the EU and emerging markets, as well as the UK, for example have launched their first ever green bonds. Chile, meanwhile, launched its first sustainability-linked bond earlier this year.
Mary argues that these landmark debut sovereign issues clearly demonstrate that governments are now active participants in the ESG market, alongside corporates and supranational issuers.
In terms of the private sector, there have been several positive developments following COP26, including growing interest in sustainability and a number of issuers pledging action for the first time. Mary says these pledges are not yet sufficient given the scale of the challenge, and that monitoring their implementation will be key, but they are a step in the right direction.
In general, there has been encouraging progress around the practice and disclosure of data. Last year, our Spotlight on fixed income and ESG* highlighted the need for improvement in this area if the sustainability market was to fulfil its potential, and developments since then have provided a sense of optimism.
The most encouraging developments have been regulatory driven. The UK and European Union remain at the forefront of disclosure, and regulations for the finance sector and the development of mechanisms to support the growth of the ESG fixed income market. The US, Canada and several jurisdictions in APAC are also moving forward with climate-related disclosures.
Elevated levels of inflation have been exacerbated by the Russia-Ukraine conflict, which has not only increased energy supply issues but also brought to the fore new ones in agricultural commodities for example. These factors are acting in tandem with longer-standing climate risks.
The second major trend has been the growth of sovereign green bonds. A number of countries in the EU and emerging markets, as well as the UK, for example, have launched their first ever green bonds. Chile, meanwhile, launched the first sovereign sustainability-linked bond earlier this year.
Samuel Mary, ESG research analyst
Sustainability in action: Green, Social and Sustainability (GSS) bonds, climate leaders and more
he global sustainable bond market has materially grown and evolved over the past few years. PIMCO recognises the impact that climate change will have on the global economy and offers investors – through their bond allocations – the means
to manage climate-related risks and take advantage of the opportunities associated with the transition to a net zero emissions economy.
The evolving fixed income market is spurring the transition to a more sustainable economy as well as enabling investors to build more diversified portfolios, say Samuel Mary and Lorenzo Brunelli
Sustainability-linked bonds are a more recent trend that is rapidly garnering interest. “The issuance we have seen in 2021 was approximately 10 times larger than the numbers that we had witnessed in the previous year,” says Brunelli, indicating that this points to a category that is likely to develop further in the years ahead.
These new instruments are not specifically dedicated to facilitating environmental and social projects, rather they are paid based on the issuer’s achievement of certain sustainability goals.
A NEW TREND ON THE HORIZON
Sustainable investment examples
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“PIMCO’s scale allows it to drive positive change”
This is particularly the case when it comes to one of the most hotly debated and researched sustainability topics of the year: climate change.
For PIMCO there are two key types of climate risk that must be considered: transition risk, which includes the risk posed by increasing climate regulation and reporting standards globally, and the physical risks from climate change, such as wildfires and floods. To measure these risks, the firm is constantly working on developing proprietary analytical frameworks and scoring methodologies.
A particularly important trend is the growth of ESG-labelled bond issuance, which is now spreading across industries and geographies rather than staying concentrated in a few key sectors. "This really helps, on one hand, with the transition to a more sustainable economy,” says Lorenzo Brunelli, ESG product strategist at PIMCO. “On the other hand, it also helps asset managers like PIMCO to build up more diversified and robust portfolios.”
Green, social, sustainability and sustainability-linked bonds are all a part of the ESG-labelled bond universe, but with key differences.
As mentioned in the previous section of this guide, green, social and sustainability bonds are use-of-proceeds bonds, meaning the proceeds are used to develop specific projects such as renewable energy, green buildings and greener transportation. In the case of social bonds, the proceeds are devoted to the likes of basic infrastructure, affordable housing or security, health and safety procedures.
“The main benefit of the use-of-proceeds format from the investor's perspective is the increased disclosure on the part of the issuer,” says ESG research analyst Samuel Mary. “For the issuer, they're getting the capital that can help advance their sustainability strategy,” he says.
Sustainability-linked bonds essentially reinforce the commitment of the issuers to sustainability in their business operations by directly tying them to their financing conditions.
“When they are well structured, it's a very strong signal from issuers that they are committed to ESG and sustainability,” says Mary.
PIMCO believes it is critical that a well-rounded sustainability strategy shouldn’t be limited only to ESG-labelled debt, even in the context of an ESG-optimised thematic strategy like the PIMCO GIS Climate Bond Fund.
“That would be sub-optimal because you would be missing a number of interesting opportunities in bond markets, especially from those issuers that are not in a position to issue dedicated instruments or use-of-proceeds bonds with a certification,” says Brunelli.
These segments could be unlabelled green bonds or they could be climate leader bonds, both of which are critical categories for PIMCO's Climate Bond Strategy – a multi-sector thematic bond portfolio that invests beyond the green bond market.
Unlabelled green bonds are issued by companies that are structurally low carbon, for example a solar panel company or an electric passenger railway company. “These are pure play or almost pure-play type of companies, and while they may not issue green-labelled, certified bonds, their businesses are nevertheless important to support the transition to a low carbon economy,” says Brunelli.
As for climate leaders, PIMCO defines them as issuers deemed to be at the forefront of net zero transition in sectors that are not structurally green. “These are issuers that are demonstrating a strong commitment to mitigate their carbon emissions at company level across the full value chain, encompassing the reduction of their environmental impact overall ,” Brunelli says.
A thorough assessment of any of these types of bonds is crucial. Having a label doesn’t always translate to high quality. “A lot of analysis has to be put in place, and that's the work of PIMCO’s ESG dedicated analyst team, to have a deep understanding of the ESG characteristics of each and every business and bond issuance,” he says.
Mary says an important trend that has been gathering pace is the development of standards to identify climate leaders and those more committed to net zero.
STANDARDS HELPING TO IDENTIFY CLIMATE LEADERS
“I’d highlight the Science-Based Targets initiative, which has essentially developed a framework and methodology to help issuers submit decarbonisation targets that are ambitious enough to be qualified as aligned with the goal of the Paris Agreement, including the most ambitious interpretation of the Paris Agreement, which is net zero,” says Mary.
“When sustainability-linked bonds are well structured, it's a very strong signal from issuers that they are committed to ESG and sustainability”
Company B SECTOR: Packaging MATURITY: September 2028 COUNTRY OF DOMICILE: Ireland Green bond proceeds to be allocated towards expenditures relating to energy efficiency projects and manufacturing of sustainable packaging. PIMCO had a 1x1 call with the company to discuss best practices for ESG bond disclosure and reporting. We recommended that the company consider leveraging additional environmental indicators to quantify the environmental impacts of its sustainable aluminium products. PIMCO also shared guidance on sustainable bond issuance and examples of lifecycle impact assessments.
green bond
Company A SECTOR: Real estate finance MATURITY: 15 April 2031 COUNTRY OF DOMICILE: United States This bond focuses on energy efficiency, green buildings, infrastructure and renewable energy-generation projects. Following the issuance of the bond, PIMCO also engaged with the company to request the creation of a green bond framework to provide a deeper level of assurance to market participants. We suggested they include language regarding exclusionary categories given their investments in the natural gas value chain.
Company C SECTOR: Materials MATURITY: 15 January 2032 COUNTRY OF DOMICILE: United States The company’s second sustainability-linked bond (SLB) includes key performance indicators centred on reducing its industrial water-withdrawal intensity by the end of 2026 and increasing the representation of women in leadership positions to 30% or more by 2025. After passing up the opportunity to invest in the company's initial SLB in 2020, PIMCO met with management to discuss their ESG action plan and provide recommendations for improvement. Following our discussion, the company announced more ambitious ESG targets and issued this second SLB, where PIMCO participated.
sustainability-linked bond
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A particularly important trend is the growth of ESG-labelled bond issuance now spreading across industries and geographies, rather than staying concentrated in a few key sectors. “This really helps on one hand, with the transition to a more sustainable economy and environment,” says Lorenzo Brunelli, ESG strategist at PIMCO. “But also on the other hand it helps asset managers like PIMCO to be able to build up more diversified portfolios, like the PIMCO Climate Bond Strategy.”
Green, social, sustainability and sustainability-linked bonds are all a part of the ESG-labelled bond universe, but, as previously mentioned, with key differences.
As mentioned in the previous section of this guide, green, social and sustainability bonds are user-proceeds bonds, meaning the proceeds are used to develop specific projects such as renewable energy, green buildings and greener transportation. In the case of social bonds, the proceeds are devoted to the likes of basic infrastructure, affordable housing or security, health or safety procedures.
These new instruments are not specifically dedicated to facilitating environmental and special projects, rather they are paid based on the issuer’s achievement of certain sustainability goals.
“When they are well structured, it's a very strong signal from issuers that they are committed to ESG and sustainability,” says Mary. PIMCO believes it is critical that a well-rounded sustainability strategy shouldn’t be limited only to ESG-labelled debt, even in the context of an ESG-optimised thematic strategy like the PIMCO GIS Climate Bond Fund.
“That would be sub-optimal because you will be missing a number of interesting opportunities in bond markets, especially from those issuers that are not in a position to issue dedicated instruments or use-of-proceeds bonds with a certification,” says Brunelli.
These segments could be unlabelled green bonds or they could be climate leader bonds, both of which are critical categories for the GIS Climate Bond Fund.
A thorough assessment of any of these types of bonds is crucial. Having a label doesn’t always translate to high quality. “A lot of analysis has to be put in place, and that's the work of PIMCO’s ESG dedicated analyst team, to really have a deep understanding of the ESG characteristics of each and every business and bond issuance,” he says.
PIMCO itself also has a size advantage. The firm is one of the largest active fixed income investors globally, with $2.0trn(1) of assets under management and longstanding relationships with clients. In 2021, PIMCO’s credit analysts engaged with more than 1,500 companies around the world to drive positive change in capital markets.
ixed income is an ideal asset class to drive meaningful ESG change. That’s because in terms of sheer size, it is larger than the equity market. And there is a strong need for issuers to engage with buyers as they have to fundraise.
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Fixed income: an ideal asset class to drive change
Engagement is the cornerstone of PIMCO’s sustainability approach, says Lorenzo Brunelli
Achieving net zero emissions is a key engagement theme for PIMCO. The firm has engaged with more than 20 global banks on implementing their carbon emissions strategies and aligning with the Paris Agreement.
ENGAGING THE ECOSYSTEM
Energy transition represents a capital deployment event of historic proportions
“Engagement is a critical element of PIMCO’s ESG investment process”
Active approach
Pothalingam adds that “a label doesn’t confirm virtue”, which means the ESG fixed income investment process is highly active. PIMCO’s proprietary methodology allows it to “say ‘no’ to many labelled bonds, since a label doesn’t necessarily mean it is aligned with ESG goals”, he explains.
Furthermore, the concentrated sources for the underlying minerals and raw materials needed for clean energy technologies cause overreliance on certain countries and supply chains, resulting in a trade-off between diversifying supplies and achieving a cleaner energy future over the shortest possible time frame. A concerted effort to reach the well- below 2.0 degrees Celsius goal would mean a quadrupling of mineral requirements for clean energy technologies by 2040. How the world ensures supply and demand remain relatively balanced for both old and new energy will be of critical importance to maintaining stability in financial markets and confidence in policymakers.
This puts PIMCO in a good position to actively accelerate change and strengthen issuers’ commitment to ESG initiatives. “We often have access to the senior executives at firms that are open to hearing our thoughts and expectations in regard to their sustainability bonds issuance and their ESG strategy more broadly,” says ESG product strategist Lorenzo Brunelli.
“We do engagement both in a bilateral fashion – a one-to-one type of private dialogue – and also in a collaborative fashion, where we join other investors under specific initiatives like Climate Action 100+,” says Brunelli.
Through collaborative effort and partnership with investors affiliated with the Institutional Investors Group on Climate Change (IIGCC), PIMCO has been able to share its expectations with these banks and has seen several already make progress.
Another crucial topic revolves around methane emissions, which are the second-largest cause of global warming. PIMCO has been engaging extensively with over 50 energy companies on reducing methane emissions through measurement-based emissions reporting, best practices in target setting, and adopting industry standards for disclosure.
Meanwhile, tackling deforestation is crucial not only for limiting global warming, but also mitigating other risks such as biodiversity loss and human rights violations. “We focus on decarbonisation but we also focus on the environmental themes that we believe are directly connected with the net zero agenda. Deforestation is a case in point,” says Mary.
The firm connects with issuers exposed to deforestation across supply chains and gives recommendations for best practices to remove it. This is of key importance for issuers with exposure to sensitive commodities like palm oil, soy and cattle.
PIMCO has found a number of companies that are moving gradually towards physical certification and full traceability of these sorts of commodities. However, it believes banks could be doing more to solidify the link between zero deforestation and net-zero commitments in their climate strategies.
“Banks are important because of their significance in fixed income markets and portfolios in general,” says Mary.
As well as working on its own, taking advantage of its size and long-standing relationship with key decision-makers at firms, PIMCO takes part in a number of important initiatives with organisations that align with its strategy and values. Partnerships are a key way for PIMCO to amplify its influence and impact.
PARTNERSHIPS ARE KEY
“A key example would be the partnership that we have with FAIRR: Farm Animal Investment Risk and Return,” says Brunelli. “It's a global network of investors addressing ESG issues in, for example, protein supply chains,” he explains. Alongside sustainable proteins, Brunelli highlights antibiotic resistance, working conditions and deforestation as key issues for the group.
Elsewhere, the Access to Nutrition Initiative aims to tackle under-nutrition, obesity and diet-related chronic diseases at a global level. Through this partnership, PIMCO highlighted nutrition strategy and disclosure with a US-based beverage distributor and manufacturer.
“We engaged with the company on its approach to defining healthy products, setting measurable nutrient targets and practising responsible promotional marketing activities, and encouraged management to align its current practices with industry standards,” says Brunelli.
“The company is now reviewing its work on affordability and responsible marketing, with the goal to improve data disclosures going forward and make the business more responsible,” he says.
Overall, ESG engagement is a critical element of PIMCO’s investment process. “What's really important for us is the direction of travel and the momentum,” says Brunelli.
“The end goal is to bolster the alignment of these issuers to the Paris Agreement on climate change, and help them to improve their underlying credit risks, moving from climate readiness to awareness, and finally alignment,” he says.
FOUR DRIVERS OF ENGAGEMENT
PIMCO has four objectives driving its ESG engagement efforts:
Steer positive impact by improving the ESG performance of the company
Expand the ESG bond universe and encourage new ESG bond issuance
Improve data quality and disclosures (e.g. data gaps on ESG KPIs and ESG bond impact reporting)
Engage to support and encourage more transparency and external reporting (e.g. alignment with industry disclosure standards)
Source: PIMCO, Transition Pathway Initiative (TPI). For illustrative purposes only.
Climate Change Engagement
PIMCO's expectations for issuers on climate change spearhead bondholder engagement
Engaging with companies on climate issues
BACKGROUND Company C is a British mutual financial institution. The bulk of the indirect GHG emissions created across their value chain (known as scope 3 emissions) relates largely to their mortgage portfolio. ENGAGEMENT PIMCO engaged with management to help shape their new sustainability KPIs, specifically on setting targets on net-zero portfolio emissions and improving the Energy Performance Certificates ratings (EPCs) for the assets secured by their mortgage lending. PROGRESS TO DATE In 2021, Company C pledged to go net-zero by 2050, joining the Net-Zero Banking Alliance (NZBA) and the Glasgow Financial Alliance for Net Zero (GFANZ). They also set a target for their mortgage portfolio to reach 50% of C-rated or above by 2030 in line with PIMCO recommendations.
A financial institution
BACKGROUND A major US utility holding company with operations in eight Western and Midwestern states, Company B serves 3.7 million electricity customers and 2.1 million natural gas customers. The company has committed to generating 100% carbon-free electricity by 2050 as well as an 80% reduction in GHG emissions by 2030. ENGAGEMENT PIMCO has engaged company management over several years regarding their green bond programme, climate disclosure and climate strategy. PIMCO encouraged alignment with the International Capital Markets Association Green Bond Principles as well as PIMCO’s Best Practice Guidance for Sustainable Bond Issuance. PIMCO emphasised the importance of transparency in green bond eligibility criteria and impact reporting, as well as firm-wide alignment with the Paris Agreement. PROGRESS TO DATE In autumn 2020, Company B published its first green bond impact report largely following suggested best practices. A year later, Company B published its first standalone sustainable financing framework, setting out the full list of eligible categories, criteria and examples, along with a second-party option provided by S&P.
An electricity and gas company
BACKGROUND A German-Czech Republic commercial real estate company, Company A, invests mainly in Central and Eastern Europe, a region that is still in the early stages of ESG investing compared to Western Europe. ENGAGEMENT Following interactions on Company A’s green bond programme and ESG strategy, PIMCO shared guidance on best practices when issuing sustainability-linked bonds, including an explicit link to ambitious GHG emissions-reduction targets. PROGRESS TO DATE In January 2022, Company A issued its inaugural sustainability-linked bond, with a strong focus on reduction in carbon emissions. The company is currently obtaining validation by the Science Based Targets initiative (SBTi) that its emissions reduction goal is aligned with the Paris Agreement.
A commercial real estate company
Sources.
(1) As at 31 December 2020
PIMCO itself also has a size advantage. The firm is one of the largest active fixed income investors out there, with $2.21tn¹ of assets under management and longstanding relationships with clients. In 2021, PIMCO’s credit analysts engaged with more than 1,500 companies around the world to drive positive change in capital markets.
This puts PIMCO in a good position to actively accelerate change and strengthen issuers’ commitment to ESG initiatives. “We often have access to the senior executives at firms that are open to hearing our thoughts and expectations in regard to their sustainability bonds issuance and their ESG strategy more broadly,” says ESG Product Strategist Lorenzo Brunelli.
Through collaborative effort and partnership with investors affiliated with the Institutional Investors Group on Climate Change (IIGCC), PIMCO has been able to impress its expectations upon these banks and has seen several already make progress.
Another crucial topic revolves around methane emissions, which are the second-largest cause of global warming. PIMCO is engaging extensively with over 50 energy companies on reducing methane emissions through measurement-based emissions reporting, best practices in target setting, and adopting industry standards for disclosure.
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BACKGROUND Company C is a British mutual financial institution. The bulk of the indirect GHG emissions created across their value chain (known as scope 3 emissions) relates largely to their mortgage portfolio. ENGAGEMENT PIMCO engaged with management to help shape their new sustainability KPIs, specifically on setting targets on net-zero portfolio emissions and improving the Energy Performance Certificates ratings (EPCs) for the assets secured by their mortgage lending. PROGRESS TO DATE In 2021, Company C pledged to go net-zero by 2050, joining the Net-Zero Banking Alliance (NZBA) and the Glasgow Financial Alliance for Net Zero (GFANZ). They also set a target for their mortgage portfolio to reach 50% of C-rated or above by 2030 in line with our recommendations.
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Source.
(1) https://www.independent.co.uk/news/uk/rishi-sunak-jacob-reesmogg-house-of-commons-library-liberal-democrats-christine-jardine-b1988412.html
Lorenzo Brunelli, ESG product strategist
PIMCO’s Climate Bond Strategy is a global multi-sector fixed income portfolio which opportunistically invests in those issuers that are demonstrating global leadership in climate action.
Fund overview
Four Core Pillars of the Strategy
Fund performance
The primary investment objective of the Fund is to seek high current income, consistent with prudent investment management. Long-term capital appreciation is a secondary objective.
Portfolio management team
As of 31 May 2022. SOURCE: PIMCO, MSCI, EPA. For illustrative purposes only Absolute carbon emissions and carbon intensity calculated using the weighted average of corporate holding in the portfolio, rather than total portfolio metrics. Carbon Intensity is defined as the weighted average Carbon emissions (Scope 1 + Scope 2 emissions in tCO2e)/Revenues in USDm. Scope 1 emissions are direct emissions from a company while Scope 2 are in direct emissions from the generation of purchased energy. Financed Carbon Emissions is defined as the absolute greenhouse gas emissions (scope 1 and scope 2) associated with a portfolio, taking into account % Ownership. Carbon Footprint is defined as the total carbon emissions (scope 1 and scope 2) for a portfolio normalized by the market value of the portfolio. Green bonds from Utilities that have aligned their business models to meet the Paris Agreement targets are treated as zero carbon emissions and therefore, zero carbon intensity given their financing of renewable projects and issuer commitments. Green bonds from non Paris aligned Utilities receive 10% of the issuer’s carbon metrics given the financing of renewable energy, while recognizing the issuer’s more limited commitments. For all other green bonds, carbon metrics from the issuer are passed to the green bond. The Bloomberg Global Agg Credit is used as a proxy for “Market Average” and is not the Fund’s benchmark. As per its KIID, the Fund is benchmarked to the Bloomberg MSCI Global Green Bond Index. Refer to appendix for additional index, investment strategy, portfolio structure and risk information.
Source:
Reduce the carbon intensity and footprint of the portfolio. Avoid those issuers in high carbon sectors who lack ambition and are not aligned with the objectives set by the Paris Agreement.
Invest in climate leaders. Invest in businesses that are at the forefront of the energy transition and demonstrating a commitment to mitigate their carbon emissions across their full value chain.
Support climate solutions through investing in both green and unlabelled green bonds. Identify and include issues driving projects fundamentally aligned to climate solutions.
Engage to influence positive change. Focus on bolstering issuers’ alignment with the Paris Agreement on Climate Change targets, supporting companies to improve their management of the underlying credit risks.
The fund's financed greenhouse gas emissions (scope 1 and 2 metric tons of CO2e) are 3,350 tCO2e less than the global credit index, which is equivalent to:
incandescent lamps switched to LEDs
tree seedlings grown for 10 years
passenger vehicles taken off the road in one year
homes powered by clean energy for one year in the United States
OR
Significnt reduction in CO2 emissions
Seeking to spot the winners of the transition to a net zero economy
Source: Issuers, US EPA, PIMCO as of 31 May 2022. For illustrative purposes only. This chart displays the potential avoided carbon emissions driven by use of proceeds bonds held in this portfolio, and based on PIMCO’s sample portfolio ownership of these bonds. We define avoided carbon emissions as the estimated greenhouse gas (GHG) emissions impact (expressed in carbon dioxide equivalent) of a product (good or service), project or investment financed by the bond relative to the situation where that product, project or investment does not exist (business as usual). We use several assumptions to derive the annual ‘avoided emissions’ number given the varying levels of disclosure. There are a number of methodological considerations associated with the concept and calculation of avoided emissions and we do not make a claim that these emissions would not have been saved without PIMCO investments.
PIMCO recognises the profound impact that climate change will likely have on the global economy, financial markets and issuers. We believe that the bond market can play a pivotal role in driving the transition to a net-zero emissions economy, thanks to its size, diversity and number of sectors, as well as the dedicated ESG-labelled instruments available to bond investors which foster near-term decarbonisation. And as one of the world’s largest fixed income managers, we believe we are well positioned to partner with bond issuers and our clients to help them achieve climate and sustainability goals over the long term.
Our Climate Bond Strategy is designed to focus on the risks and, importantly, the opportunities associated with the momentum for greater climate action, and it supports the pathway to a green and resilient economy. For those investors with long-term sustainability objectives, we encourage them to consider allocating a portion of their bond portfolios to high quality issuers in the rapidly expanding ESG bond market.
CONCLUSION
The Fund invests across three key segments: 1) green bonds – those labelled green and displaying best practices; 2) unlabelled green bonds – issuers driving projects that are fundamentally aligned to climate solutions; and 3) climate leaders – industry leaders of environmental action (see below).
The fund represents PIMCO’s best ideas in climate solutions. The strategy aims to help foster the transition to a net zero carbon economy while seeking risk-adjusted returns comparable to an investment grade credit portfolio, investing beyond the green bond market.
The record net issuance that PIMCO has seen over the past few years and the increasing number of first-time issuers has helped to build a well-diversified global bond strategy across sectors and geographies.
The opportunity set of the strategy goes beyond the traditional fixed income sectors; as an example, the Fund can invest in solar asset-backed securities (ABS), which are a way of obtaining exposure to renewable energy projects.
“We have continued to focus on those issuers that are finding innovative ways to integrate sustainability across their full value chain, including, notably, setting up science-based targets,” says Brunelli.
Currently, over 50% of the corporate holding of the climate bond strategy is invested in issuers that have either set or committed to set science-based targets according to a number of emerging evidence-based standards. (1)
Three segments
Select examples
Green bonds
Unlabelled green bonds
Climate leaders
Issued with use-of-proceeds devoted to environmental projects—displaying best practices
Issuers fundamentally aligned to low-carbon products and services, including renewable energy ‘pure-plays’
Issuers that lead in mitigating carbon emissions and broader environmental externalities across their value chain
A renewable energy provider using green bond proceeds for wind/solar
A global bank developing innovative forms of finance to support a low carbon economy
A renewable energy company growing by acquiring and investing in low-carbon-generation assets such as solar, wind, geothermal and hydro-electricity
A municipal-owned water system financing improvements to sewage treatment works, water quality improvement projects or flood control facilities
A real estate company issuing green bonds targeting emissions reductions targets for its corporate operations and logistics
A food company planning to remove deforestation its from supply chain via a sustainable sourcing policy
386,277
169,318
2,194
1,172
Steer positive impactby improving the ESG performance of the company
55% improvement
GIS Climate Bond Fund
Bloomberg Global Agg Credit Index
SELECT COMPANY TO VIEW STORY
(1) 57% as at 31 May 2022
If you are interested in learning more about our Climate Bond Strategy please contact us or visit our ESG page
Building the Portfolio Bond by Bond