SRI-boot now on bond foot?

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As pension funds have shunted their asset allocation towards bonds at the expense of equity weightings, has their power to take a stand on social responsibility weakened? After all, bondholders do not have the voting rights of equity holders, and many debt issues stem from non-listed organisations with lower levels of public disclosure.

But those in the industry say fixed-income can be subjected to SRI criteria in much the same way as shares, and voting is only one way of exerting influence on a company.

Stewart Armer, head of SRI at Fortis Investments, has seen more large investors seeking to subject bonds to the same SRI principles as equities. "An increasing number of institutional investors are looking to apply SRI criteria to their fixed income portfolios," he says.

Armer puts this trend down to two factors. There is now more interest among investors in SRI approaches, he says, and at the same time, investors have been shifting their asset allocation more towards aggregate bond products, involving investment in corporate bonds. Investment in corporate bonds has a clear link to the kind of company-specific SRI analysis currently being carried out in the equity sphere, says Armer.

"One interesting aspect of bond SRI products is that they open up the investment universe to a wider range of issuers, such as development banks, which have obvious attractions to socially responsible investors," he says.

Fortis Investments is launching an SRI aggregate bond product this autumn, he says, in response to market demand.

Some pension funds in Europe have SRI policies that are only applied to their equity investments. In Sweden, the seventh national pension fund AP7 does apply SRI criteria to its portfolio, but only the equity part, says Peter Norman, executive president of the fund. Its fixed income portfolio only consists of Swedish government bonds, he points out.

"I think the market for applying SRI to bond portfolios is quite immature… some are doing it, but it is quite rare," he says.

Research on the social responsibility of companies issuing bonds is not always as widely available to investors as it is on those with stock market listings. Though many bond issuers also have an exchange listing, many do not. However, some research firms do specific analysis of listed bond issues. "We offer our clients research on companies on the one hand, and on listed bond issues on the other," says Matthias Boenning, head of research at Oekom Research in Germany. The firm assesses a lot of financial institutions that issue debt but which do not necessarily have shares listed, such as mortgage banks.

"Many of our clients have specialised bond funds, or at least mixed funds," he says. In Germany, the best-in-class approach to SRI selection tends to be more commonly used than the negative screening method that prevails in some other countries, he says. Oekom assesses issues according to sustainability criteria, which results in rankings, and investors then plump for those companies that come highest in the chart.

On the whole, European investors are not as involved in engagement with the companies they invest in to encourage socially responsible activity, as US and UK investors, he says. "Engagement is not such a big thing in Europe," says Boenning.

One of the main differences between debt and equity is that debt generally conveys no voting rights to its holders. Because of this, there is a common perception that it is harder to make bond issuers take investor views into consideration than it is to make share issuers listen.

But Boenning says this makes less difference from an SRI point of view than seems to be the case. "Even if there are no voting rights, huge investors certainly have an influence… those that are big enough can exert an influence on issuers that is quite comparable to those that have equities," he says.

Rory Sullivan, head of investor responsibility at Insight Investment in London, acknowledges the argument that applying SRI considerations to fixed income is more difficult because of the lack of voting rights, but does not agree with it.

"That underestimates the influence a bond investor has," he says. "Our experience has been that voting is a very small part of the influence we can have. Our views and our analysis of social and environmental values feeds back, and they are hugely important…. Apart from voting, it's the same dialogue."


owever, SRI research on unlisted companies can be harder to come by. Boenning says these issuers of debt often do not face the same degree of pressure from stakeholders to be open, and as a result, there is much less available than there is from those that are listed.

"We really have to get into a dialogue with the issuers and hope to get information that is not publicly available," he says. "Awareness is much less developed, and there are not many rating agencies that approach bond issuers on sustainability issues."

But it is just a question of time before this changes, he adds.

The large supranational bond issuers, such as the World Bank and other major government-linked issuers such as the Kreditanstalt fuer Wiederaufbau can be a rich source of fixed income assets for pension funds in Europe. Their debt has clear appeal from the point of view of its credit rating, but its creditworthiness has no bearing on the issuer's credentials regarding social responsibility.

Though development banks can meet an investor's SRI aims in some ways, there are often details of their business that must be scrutinised more closely.

"It is quite necessary to assess whether they have controversial guidelines with regard to lending," says Boenning. One has to look at their suppliers and their actions regarding human rights, for example. Development banks finance projects all over the world, and SRI researchers have to question whether, in their financing of pipeline and power station construction, social and environmental considerations are made.

"We have a country rating, and of course there are differences between countries regarding human rights and social, education and jobs policies," he says. A country's rating will also depend on whether it is trying to reduce greenhouse gas emissions, he adds.

"Investors who want to invest in a larger number of governmental bonds should base this decision on research," he says.

High-profile corporate collapses such as Enron have served as reminders about how important it is for bond investors to know how well companies are being run. "Governance is taken as a given as one of the things bond investors look at," says Sullivan.

But other issues that lie within the field of SRI may or may not have such an obvious connection with the success of an investment.

Climate change is one that is clearly relevant, according to Sullivan. "These are long-term issues that are likely to emerge over the life of a bond," he says. "Over a 10, 15 or 20-year period, which is typically the life of a corporate bond, it is quite likely that we will see the impact of climate change emerging.

"There are things that are clearly material and it would be remiss of an investor not to integrate them into standard analysis," he says. Although there has been a high degree of scepticism among mainstream investors that the SRI agenda has any place within serious investment, many of these issues should be treated with the same degree of seriousness as any other issue, says Sullivan.

"Pension funds have struggled with the idea of SRI and bonds, because they've assumed… it means some kind of screening, with some kind of implication for returns," he says. "So this is why it hasn't really been applied in the institutional market."

Insight Investment questions whether this is the right way to look at it, he says. "One of the first things, is that they should confirm that their investment manager properly integrates these issues into analysis," he says. "The second thing they can also ask the fund manager is whether they engage with the company to encourage standards of corporate responsibility."

There is a lot that pension funds can do to ensure the integrity or quality of the underlying asset, he says.

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