Sustainable Investing

Western Asset’s research analysts examine ESG factors at the issuer level, focusing on those that can potentially affect creditworthiness. We draw upon proprietary research as well as third party models to assess an issuer’s ESG performance and outlook. The types and relative importance of factors vary depending on the sector as well as the individual issuer. Investments that do not meet Western Asset’s standards are treated as having higher risk, as their future ability to pay may be adversely affected by developments such as legal sanctions, the introduction of new regulations or shifts in consumer sentiment. We then evaluate whether the market is appropriately pricing the issuer’s performance based on those ESG factors.

A growing number of the issuers we consider for investment have exposure to environmental factors that must be weighed when building portfolios. Traditionally, these have included utilities for which regulation places precise requirements around environmental quality factors. Western Asset has also long recognized the environmental challenges inherent in heavy industry sectors such as metals and mining, machinery, and oil and gas. However, environmental concerns apply across many other sectors as changes in energy costs and in climate conditions may have pervasive effects.

Social factors can also impact consumers’ perception of an issuer as well as the issuer’s operations. We consider a number of social factors, including employee relations, workplace safety practices, consumer protection policies, recruiting and talent development, and community relations. Social considerations are particularly important in our evaluation of sovereign issuers, where demographic composition, socioeconomic trends and income distribution can affect the growth trajectory of a country.

Governance plays a critical role in Western Asset’s ESG analysis, as it lays the foundation for a well-run, sustainable business. We consider governance crucial not only as a standalone risk factor, but also as a signal for how the issuer manages its long-term environmental and social issues. Without superior governance practices, which include proactive management, robust reporting and strong risk controls, Western Asset cannot have confidence that leadership and integrity will be in place for environmental and social factors.

With all ESG factors, we evaluate the extent to which each issuer is adapting to improve its practices in the changing environment. Western Asset views corporate sustainability initiatives and disclosures as important indicators of how issuers manage their operational costs, and we further develop our understanding through dialogue.

Engagement with management allows our research analysts to obtain additional perspective on ESG concerns that are inadequately addressed by existing policies and disclosures. In some cases, particularly with privately held issuers, our research analysts can serve to increase awareness of the importance of ESG considerations through their conversations with management.

Although bondholders obviously possess very different legal rights than shareholders, Western Asset believes it can impact corporate ESG practices given its role in determining issuers’ cost of debt capital. As long-term, value-oriented investors, we require compensation in wider spreads from issuers that lag their peers in ESG practices. Conversely, we reward issuers whose ESG profiles we believe will improve but whose spreads overcompensate for historical deficiencies.

Asset owners can vary greatly in terms of the specific values and themes they seek to express in their portfolios. While we have historically integrated sustainability analysis into all of our portfolios as part of our fundamental value research, we also closely partner with clients committed to sustainable investing who desire to overlay views of a more specific nature (e.g., environmental preservation or exclusion of specific business activities).

Looking forward, we recognize that sustainable investing across fixed-income sectors is evolving. Through collaboration with other institutional investors, we seek to shape its progress.