Future of Investing 2019

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F U T U R E O F I N V E S T I N G 4 t was only two years ago that the world's first Sustainable Development Goal (SDG) bond was issued. Twelve months later, lead- ing fixed-income investment manager PIMCO reports that 27 per cent of issu- ers they engaged with unveiled sustain- able or green bonds during 2018. Fast-forward to summer 2019 and the UK government has announced plans for mandatory reporting on climate risk by pension schemes. Changing times for investment The sheer volume of environmental, social and governance (ESG) questions coming through now from asset owners and consultants is indicative of chang- ing times, says Olivia Albrecht, head of ESG business strategy, at PIMCO. "There is a groundswell of under- standing today around ESG, and 2019 feels fundamentally different from 2017 and 2018," she says. "Clients who historically focused only on the equity portion of portfolios are now increas- ingly interested in fixed income, with an upsurge in product development happening too." As asset owners target ESG and sus- tainable investment, issuers are also prioritising integration of practices and are on the lookout for projects to finance. So, while ESG may still largely be an emerging trend, its evolution is swift, notes Lupin Rahman, PIMCO head of emerging market sovereign credit. "In 2017-18 you had a sharp accel- eration in green bond issuance in the corporate space," says Ms Rahman. "Now this theme is really moving into sovereign territory with green bond issuance by countries such as France, the Netherlands and Chile." The reach and remit of ESG is also expanding beyond the environmen- tal domain of so-called green finance, aligning with wider SDGs. This growth in demand looks set not only to continue, but increasingly see ESG factors formally incorporated into all investment decisions, not just dedi- cated ESG-labelled portfolios. Furthermore, as understanding of economic effects improves, the market is rapidly realising ESG considerations are material in driving fixed-income and risk-adjusted returns, adds Ms Rahman. "The old way of thinking was that ESG is just about doing good, but what markets are recognising more and more, be it related to environmental issues, social factors or governance, is that all these considerations have an impact on financial returns," she says. Key to ESG mainstreaming over time, however, will be the performance component, says Ms Albrecht. "One question that keeps coming up on the part of investors is whether an ESG- style approach means an automatic give-up of performance expectations. The answer is simple: no. There need not be a performance sacrifice with ESG if the opportunity set is suffi- ciently broad. In fact, what we need is something of a mindset shift to bust this persistent myth." Materiality, risk and 3Es At PIMCO, ESG investing is underpinned by a fundamental focus on material- ity of risks. Its integration is broad- based across the firm, involving every risk-taker and informing all aspects of fixed-income investment, rather than remaining a siloed sideshow. This approach is systemic and stra- tegic, explains Ms Rahman. "ESG is not a matter of reinventing the investment wheel. At PIMCO we have been think- ing about factors that we deem drive returns over longer-term horizons for some time, incorporating cost-benefit analysis into bigger-picture sustainabil- ity planning," she says. Adopting a top-down perspective, as well as bottom up, for instance, means exploring how climate risk is going to impact macro-forecasting, which in turn affects central bank policies, then the stability of financial markets. In part, this risk intelligence and forecasting capability at PIMCO is borne out of the natural behaviour cycle of the fixed-income market itself. Issuers have to come to market repeat- edly to finance their debt position, which facilitates dialogue. More specifically, the PIMCO approach to ESG follows a three-stage process, known as the 3Es: exclusion, evaluation and engagement. While exclusion and evaluation are familiar to investors, it is perhaps engagement that is the real differentiator around ESG, says Ms Rahman. "Our engage- ment activities help us to identify improving ESG issuers that may offer greater value add in terms of returns," she says. "We want to influence that process." With a significant credit analyst and IT team devoted to ESG, PIMCO is able to seize engagement opportuni- ties effectively. As a consequence, its annual ESG Investing Report for 2018 reveals issuer engagement grew year on year, rising to 81 per cent from 69 per cent in 2017. In total, last year PIMCO conducted over 5,000 meetings and calls with issuers at or near the C-suite level. This extensive, elite access enabled the firm to enjoy a highly representative cross section of open discussions with many chief executives and chief financial officers, often going beyond the usual financial and balance-sheet metrics to tackle targeted sustainable develop- ment issues. Once again, the two top ranking SDG themes – climate action, and decent work and economic growth – remained the most important themes in 2018, with more than half of companies PIMCO engaged with highlighting these goals as priorities. Social issues such as gender inequality, standards of educa- tion and good health all ranked higher with issuers than in 2017. Influence is investment driven As an industry leader in fixed-income investment, PIMCO is better able to structure financial market securities to fit with sustainable investing consider- ations and mitigate specific ESG risks. PIMCO was also an early mover around what would now be regarded as ESG issues, having launched one of the first socially responsible bond funds in 1991, in the United States. This position as thought leader effectively brings with it a responsibility for PIMCO, acknowledges Ms Rahman. "We are working with a large number of industry groups on ESG, whether UN principles for responsible investment (UN PRI) or central banks and govern- ment regulatory bodies. So, that role as a global citizen is very important in helping shape ESG policies and disclo- sures," she says. Just as $1.8 trillion in assets at PIMCO alone is significant, this collabora- tive potential is much bigger still, says Ms Albrecht. "Our influence is most powerful when we come together as an industry and collectively drive change, whether through the Sustainability Accounting Standards Board or via the Climate Action 100." Fundamentally, though, it remains vital not to lose sight of primary business and financial drivers. She con- cludes: "At PIMCO, our ESG capabilities sit within the investment team. So they lean upon our in-house expertise across the full fixed-income universe. Ultimately, crucially, this is investment driven." Please speak to a financial adviser to explore new possibilities with PIMCO Why bond markets are critical for a sustainable future Some markets are bigger than others, and the fixed-income universe is almost 50 per cent larger than the world of equities. So when the sleeping giant of sustainable investing stirs, change starts to happen, fast Commercial feature I SUS TAINABLE BONDS 27 per cent (39) of the 147 companies PIMCO engaged during 2018 have issued sustainable bonds. The pie chart below gives the breakdown of these bonds PIMCO, December 31, 2018 82.9% Green bond 4.9% Social bond 12.2% Sustainability/ SDG bond Socially responsible investing is qualitative and sub- jective 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. Investors should consult their investment professional prior to making an investment deci- sion. 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. ©2019, PIMCO. In 2019 PIMCO received an A+ rating (highest score) from our UN PRI Assessment Report Why gender-equal fi rms are better investments Gender initiatives are more than just a diversity and inclusion exercise – they are good for business and should matter to investors orkplace gender equality is hardly a muted subject, but when delv- ing deeper into nuanced or spe- cifi c sectors, it's perhaps making less noise than you'd expect. Industrial settings, in particular, still struggle to convert this often lauded theme into tangible evolution. The disparity is not just boardroom related, but perhaps even more pronounced among the general workforce where employment opportuni- ties are most abundant. Entrepreneurs, analysts and industry leaders alike are now urging gender pro- gression not just as a box-ticking quota exercise, but to make organisations more functional and operationally sound, and ultimately to improve their attractiveness as an investment proposition. Bonnie Roupé, a serial Swedish entre- preneur who followed up her publish- ing enterprise in the leisure sector by conquering more industrial territory in healthcare via the online midwifery app Bonzun, has battled male domination. But she is now seeing fi rst hand how compa- nies can become more appealing to inves- tors as a consequence of top-to-bottom gender equality. "Over the years, I've experienced regular occurrences of gender bias, as a standard issue," she recalls. "This was particularly with international investors who had a well-documented set of, let's call it, 'issues' with female entrepreneurs. Endless stud- ies have documented the dearth in capital and the odd treatment that women went through during fundraising especially." Ms Roupé believes that as more female entrepreneurs have risen to the top, how- ever, the more this bias has been at least recognised and scrutinised. She continues: "We have societal norms, old habits and comfortable categorisations that steer us, and we have to make sure we are going through regular checks and bal- ances to identify where we have gaps and to address them. That includes power dynamics in the boardroom right down to how staff are treated, how sexual harassment is addressed in the workplace, to how women and girls are portrayed in marketing material. "Diversity is a powerful tool and should be leveraged on all levels. Better decisions are made, better performance is achieved and anyone falling behind is either leaving value on the table, or worse, destroying it." In Canada, the International Finance Corporation (IFC) has formed a potent partnership with the government to address the gender issue in industrial set- tings from this vital angle of value. Matthew Staff W E Q U A L I T Y "Gender diversity is good for business and matters to investors," says Veronica Nyhan Jones, head of advisory at the IFC's Infra- structure and Natural Resources Department. "Research has consistently demonstrated that gender diversity in the workforce, including management, among suppliers and in com- munity engagement, increases innovation and productivity. It also strengthens supply chains, improves social licence and reduces friction with key community stakeholders. "For instance, according to EY, for three years consecutively, the top 20 most gen- der diverse power utility firms had a 15 per cent higher return on investment than the bottom 20." IFC has found that hiring women in non-traditional roles could increase fi rms' productivity by as much as 25 per cent through gains in maintenance costs and lower turnover. All this inevitably equates to a more val- uable business and an increased likelihood of investor interest. Ms Nyhan Jones adds: "As companies rec- ognise the business value of gender diversity, shareholders and investors are increasingly valuing it as well, holding companies account- able for doing the right thing, the smart thing, and being more transparent in their eff orts to build gender-diverse businesses." Investors, just like governments and potential partner companies, are now aware that increasing female infl uence at all rungs of a business, in any sector, is a business necessity, not just a moral objective. IFC is seeking to be a catalyst in this push and has subsequently introduced a Gender Toolkit aimed at "unlocking opportunities for women in business for oil, gas and min- ing companies". In addition, IFC and the government of Canada have teamed up for a fi ve-year Energy2Equal plan which will support sub-Saharan African companies to reduce gender gaps, not through traditional meth- ods of calling out guilt and prejudice, but again by demonstrating the fi nancial and investment boost that is being missed should companies fail to evolve. The theory, which can be replicated and applied to all walks of business, but strongly hits home on an industrial level, is that a much needed snowball eff ect is pos- sible as a result. Ms Roupé believes there has been too much focus on boardrooms over the years and not enough on female leadership in executive teams, and the infl uence they can have on women who are intimidated or void of role models. "At present, it's always the same women in multiple board roles, and there needs to be more room for others to come in and help change the ingrained perception that a board member is a white, old man," she concludes. Those companies that realise this poten- tial and encourage complete gender inclu- sion from top to bottom will reap the strongest fi scal and investment rewards in the future industrial landscape. IMPAC T OF DIVERSIT Y ON INNOVATION RE VENUES Share of revenues that companies have generated from enhanced or entirely new products or services in the most recent three-year period 15% 15% 25% Innovation revenue Innovation revenue Innovation revenue 0-10% share of women in management 11-20% share of women in management 20%+ share of women in management Boston Consulting Group 2017 Better decisions are made, better performance is achieved and anyone falling behind is leaving value on the table or destroying it Canada's International Finance Corporation (IFC) has laid out an ambitious, but much needed, set of goals to improve levels of gender equality among clients, especially in industrial settings. These range from quadrupling annual fi nancing for smaller businesses led by women, scaling up commitments to fi nancial institutions targeting women to the tune of $2.6 billion by 2030 and ensuring 50 per cent female representation across its own board member nominees. The company's head of advisory for infrastructure and natural resources Veronica Nyhan Jones emphasises that such initiatives aren't simply a diversity and inclusion-induced banging of a drum. They're a concerted promotion of strategy to make businesses more operationally excellent and, as a result, more valuable. The recent introduction of an IFC Gender Toolkit is targeted at helping companies realise just that, as Ms Nyhan Jones explains: "The toolkit aligns with the IFC's own requirements of making gender equality a priority by providing concrete tools on increasing gender across natural resource operations. "Implementation of this toolkit in natural resource sectors will enhance women's participation in the supply chains of companies in these sectors and promote their economic empowerment." The desired outcome is that gender equality in the workplace becomes a natural business and value-driven decision, rather than a compulsory balance requirement in the years to come. IFC Gender Toolkit

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