Opinions expressed in AGB blogs are those of the authors and not necessarily those of the institutions that employ them or of AGB.
Over the last decade the merits of sustainable investing strategies have moved quickly to the mainstream, as investors increasingly consider both the positive and negative impact of their investment portfolios. Still, for boards and investment committees, the move to adopt investment strategies that integrate environmental, social, and governance (ESG) factors can be a polarizing conversation. To help surmount this challenge, investment grade fixed income may be the logical first step in your discussions.
ESG Adds Rigor to Your Investment Research
ESG investing prompts investors to take a more holistic view of risks and opportunities, particularly those that reflect a company’s sustainable business practices. We believe risk analysis is more rigorous when it is forward looking, which can add resilience to a bond portfolio. For endowments that, during market volatility, count on the predictable cash flows of investment grade fixed income, an ESG component can add to that reliability. Because ESG analysis adds risk considerations, such as climate or strength of governance, that traditional research alone may not consider, investors may gain a more complete view of the likelihood that an issuer will reliably meet principal and interest obligations to bond holders. As such, for investment committees considering where to start with ESG, investment grade fixed income could be a worthwhile first step.
Comparing Capital Assets and Financial Assets
It stands to reason that there should really be no disconnect between the way a university invests its financial assets and its capital assets. Is there a board today that would approve updates to a campus master plan that do not consider sustainability? Likely not. Energy efficiency, waste management, stakeholder engagement, and customer demand all speak to the valuable role that sustainability plays now and for the future of university capital assets. Clearly managing financial assets demands the same forward-looking perspective.
ESG Is Not a Product
Start with the understanding that ESG is not a product. It is an investment philosophy. If ESG is material to the long-term returns for socially responsible investors, there is no reason to believe why it would be any less material for all investors. As such, financial service firms that offer ESG strategies should extend that philosophy to their full investment lineups. Indeed, the impact of ESG is its scalability. Additionally, like the sustainability connection between financial and capital assets ESG can be a valuable management tool and should be reflected in the business practices of the investment firms that espouse it.
Aligning Investments with Mission
The universe of stakeholders in higher education is broad and diverse: students, faculty, alumni, local community. The list goes on. Unlike an environmental foundation, for example, with a more focused group of stakeholders, it may be more of a challenge to tailor a university endowment that reflects the sometimes-disparate concerns across many levels of stakeholder engagement. With that said, ESG integration may provide a resolution by recognizing and evaluating the materiality of concerns from any variety of honest voices. Indeed, through an ESG lens, the very issues being raised by those voices may well be relevant to the performance of long-term investment returns. Through their reflections in the ESG investment approach, investment committees can more easily bridge varied interests across divides than blunt approaches, such as divestment, can create for investment committees.
Do Not Stop There
A conversation about ESG investing may lead to a discussion of impact investing. Impact matters. Soon enough, investors may be tracking more than just quarterly returns, more carefully measuring the benefits and costs financial assets have for society at large.
Measurement of and reporting on impact will likely be key to both the stewards of endowment assets and the financial firms that service them. ESG investing incorporates documentation and materiality of impact in its approach through both reporting frameworks that are already well developed to help standardize reporting and through direct engagement with leadership. Companies, industry organizations, rating agencies, and government sponsored entities are responding quickly with transparency and compliance.
Foundation boards may enjoy the additional advantage of ESG and impact reporting from the organizations in which they invest. The added information and data provided by these groups may help further inform and enrich discussions with donors and other stakeholders.
Separate Accounts Offer Key Benefits
For mission-driven investors, impact may also mean avoiding conflict between how financial assets earn their returns and the ethos of the foundation and the university it supports. Understandably, impact can be in the eye of the beholder. What is impactful for a faith-based institution may be very different from what is considered impactful for a university with an environmental priority.
For investors determined to tailor their investments to align with their values, customization is essential, thus making separate accounts more practical than mutual funds. As well as providing a workable solution for amplifying impact, separate accounts deliver the strategic advantage of owning fixed income securities and the cash flows they generate directly.
A portfolio of investment grade bonds owned directly through a separate account can offer a haven from market distress. If the portfolio is managed well enough to avoid defaults, an investor who stays the course can continue to earn a steady and reliable cash flow of both income (coupons) and capital (principal) independent of the market. That independence is important to how an investment grade fixed income allocation helps an investor cope with market dislocation. Essentially, bond portfolios can be self-liquidating, so direct bond investors are inherently less beholden to the market and better able to look beyond periods of market distress.
Investment committees looking to take a first step should consider starting with investment grade fixed income where rigorous investment research is paramount to risk mitigation and sustainability is intrinsic to investment outcomes. ESG integration is an investment approach, not a product, and how financial firms integrate sustainability can more broadly validate their ESG philosophy. There need not be a disconnect between how boards steward capital and financial assets. Just as universities integrate sustainability in capital spending plans, so too can investment policy statements elevate the role of sustainability in asset selection. Sustainable investing can help boards engage with donors and stakeholders. Separate accounts are a viable solution for investors looking to customize their investments.
Endowments have long-term financial goals, but most investors can be short-term evaluators. In fixed income, ESG integration and measuring impact introduces a discipline that inspires investors to raise their sightlines on the horizon, facilitating a sustainable flow of capital as a long-term investor to responsible corporate and government borrowers. In doing so, foundation boards and investment committees can more intentionally align their investments with the long-term financial commitments of the foundation.
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The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of December 31, 2020 but are subject to change without notice.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will provide improved risk-adjusted returns over any specific time period. Investors should consult with their financial professional before making any investment decisions.
With Thanks to AGB Sponsor: Breckinridge
Tim Coffin is the senior vice president and director of sustainability for Breckinridge Capital Advisors.