Addressing climate change has become a priority for business leaders and policymakers globally as risks and realities mount and as people around the world become more concerned and engaged. Investors are demanding to be part of the climate solution, and we believe fixed income investments in particular can help drive the transition to net zero carbon emissions while seeking positive financial returns. In this Q&A, Scott Mather, PIMCO’s CIO U.S. Core Strategies and head of ESG (environmental, social, governance) investing, Jelle Brons, investment grade credit portfolio manager, Ketish Pothalingam, U.K. credit portfolio manager, Samuel Mary, ESG integration analyst and climate specialist, and Olivia Albrecht, head of ESG business strategy, introduce PIMCO’s Climate Bond Strategy, the firm’s first sustainably themed opportunity for investors to target global climate action with their bond allocations.
Q: How can bond investors help drive climate change solutions?
Mather: The global bond market is almost double the size of the equity market ($114 trillion vs. $69 trillion1), and we believe fixed income as an asset class is unparalleled in its ability to drive meaningful action to address climate change risks.
Climate change is catalyzing innovative ideas from experts in every field. At PIMCO, we aim to do one thing exceptionally well: We build fixed income portfolios to help clients meet their financial and nonfinancial objectives; increasingly, climate risk mitigation is an explicit objective for global investors. We developed a climate strategy that focuses on both the risks and, importantly, the opportunities associated with the transition to a net zero emissions economy.2
PIMCO Climate Bond Strategy is the newest addition to our sustainable investing business, which began in 1991 with one of the industry’s first negative screen bond strategies. In 2017, we offered ESG versions of our traditional bond strategies – providing the building blocks for investors seeking to build ESG-focused portfolios across asset classes. And today, we provide a strategy for investors to specifically allocate capital to bonds addressing a sustainability theme: in this case, climate action.
Q: What is PIMCO Climate Bond Strategy, and how does it support efforts to mitigate major climate risks?
Brons: The Climate Bond Strategy offers a multi-sector credit portfolio that aims to help foster the transition to a net zero carbon economy while seeking risk-adjusted returns comparable to an investment grade credit portfolio. The Climate Bond Strategy opportunistically invests in those demonstrating global leadership of climate action through labeled and unlabeled green bonds targeting specific low-carbon investments, as well as the bonds of issuers demonstrating innovative approaches to environmental sustainability. The Climate Bond Strategy is a flexible, multi-sector bond strategy that invests across investment grade and high yield credit, municipals, emerging markets, developed sovereigns, quasi-sovereigns, asset-backed securities, and currencies, and we manage the portfolio with a thematic focus on climate risks and opportunities.
PIMCO is one of the world’s largest fixed income managers, and we believe we are uniquely positioned to partner with bond issuers for the long term to help them achieve their climate and sustainability goals. There are plenty of strategies that allocate to green bonds, but we want to use our scale to do even more; as active investors, our goal is not just to find opportunities, but to create them by engaging with issuers. Importantly, our process also seeks to leverage our broader ESG platform to help mitigate social and governance risks and foster a holistic approach to climate action.
Q: Why is now the time for investors to consider a thematic climate bond strategy?
Albrecht: From a top-down macro perspective, the economic disruption of climate change is real and compounding. We believe climate change could transform human lives, economic activity, and financial markets, with multiple negative outcomes but also some positive developments. Active investment management proactively assesses and navigates the risks and opportunities of climate change.
Examples of the secular shifts already underway include the growth in low-carbon energy: renewable sources, improved efficiency, and electric vehicles. And on a much more somber note, extreme and destructive weather events are becoming more frequent, according to the World Meteorological Organization, and many governments and communities struggle to respond and adapt.
From a bottom-up credit perspective, the opportunity set has grown substantially over the past few years: It’s no longer an “either/or” choice between financial performance and climate action. Looking specifically at green bond markets, they have seen record issuance of $212 billion in 2019 year-to-date through September, versus $182 billion in all of 2018. Total green bond issuance from 2007 to September 2019 has reached $787 billion.3
Growing numbers of issuers are bolstering their climate strategies, making commitments to carbon neutrality, working toward climate adaptation, and addressing the financing needs of the Paris Agreement4 – both within and beyond the now established green bond market. This is why we are launching PIMCO Climate Bond Strategy now.
Q: What types of sustainable solutions are financed by the bonds in this multi-sector strategy?
Mather: The wide range of bonds in the Climate Bond Strategy may finance climate solution projects such as renewable energy, green buildings, more sustainable supply chains, bank lending to support a low-carbon economy, or even food companies focused on plant-based products.
As a thematic bond strategy, the Climate Bond Strategy will focus not only on the rapidly expanding market in green bonds mentioned above, but also on “unlabeled” green bonds and the debt of issuers demonstrating leadership in addressing climate risks and opportunities. As such, we avoid fossil-fuel-related sectors in this strategy,5 in addition to other industries that are fundamentally inconsistent with a sustainability-linked portfolio, like alcohol, gambling, or tobacco, among others.
Here are examples of the kinds of climate solutions promoted by the three areas of climate-related fixed income in the Climate Bond Strategy. We build and manage this portfolio bond-by-bond because we believe active management and rigorous analysis, building on insights from our credit research team, will help us spot the likely “winners” of the transition to a net zero carbon economy:
- Green bonds are debt securities issued explicitly for environmental or climate-related projects. Proceeds from a green bond issuance finance the capital expenditures needed for wind and solar energy projects and facilities, for example, or could prop up new methods for banks to support circular, more environmentally sustainable business models.
- Unlabeled green bonds are debt securities of issuers materially exposed to climate solutions, like a solar company or a passenger rail transportation company, rather than an explicit green project. While such issuers may not issue green bonds, their businesses nevertheless tend to be important to support the transition to a low-carbon economy.
- Bonds of climate leaders, as we define them, are debt securities of issuers we deem to be at the forefront of the net zero transition. These issuers have demonstrated commitment to mitigating carbon emissions and their broader environmental footprint, in sectors that may involve water, plastic, air pollution, or biodiversity. They are those we have identified as finding innovative ways to integrate sustainability across their value chain, notably via science-based targets and other emerging evidence-based standards. Examples include real estate investment trusts (REITs) with clear and focused environmental strategies, and food companies committed to ending deforestation and sustainably sourcing their products.
Q: How does PIMCO actively engage with bond issuers to encourage innovative projects to address climate risks and opportunities?
Albrecht: As long-term investors, we see the value in partnering through several rounds of bond issuance, encouraging issuers to advance their own sustainability goals and ultimately issue a green bond or even a bond linked to the UN’s Sustainable Development Goals (SDGs). This can be a direct way to use our size and scale to influence positive change, helping nurture the market and encouraging issuance of more green and SDG-aligned bonds that could benefit all stakeholders, including investors, employees, society, and the environment.
In one example, PIMCO engaged with a utility company through the UN Global Compact (UNGC) for several years on their commitment to renewables and more recently through their participation in the UNGC / PIMCO symposium on SDG bonds held at our Newport Beach office in 2018. Not long after, the company issued an innovative SDG-linked bond and enhanced its status as an energy transition leader with a focus on renewables.
Active engagement is one example of how PIMCO’s size, scale, and market leadership in partnership with organizations like the UNGC are creating opportunities for fixed income investors. PIMCO is also part of Climate Action 100+, an investor-led climate coalition that engages with systemically important carbon emitters.
Q: How do long-standing relationships in the bond market help drive the category forward on climate action?
Pothalingam: Engagement among major players is crucial for global financial markets to continue evolving toward sustainability. For example, following a social impact self-assessment, a leading banking company began targeting CO2 reductions within its loan books. Based on our established presence as a large buyer of bonds in the banking sector, the company approached PIMCO to discuss a framework for sustainable lending. In our discussions, we provided guidance on what our requirements were for transactions targeting specific SDGs. A few months later, the company came back to PIMCO to discuss the specifics of a bond targeting environmental categories and those linked to positive social impact, especially with a focus on emerging markets and underserved populations via a mix of microfinance and small and medium enterprise (SME) finance.
Q: What expertise does PIMCO offer investors in managing a climate-themed strategy?
Mary: As an active manager, we are always seeking to gain an informational and analytical edge in security selection, and climate-driven risks and opportunities are no exception. We have developed several proprietary tools (see Figure 1) to help uncover opportunities and manage climate risk in investment portfolios:
- To ensure we have a robust long-term, top-down perspective on climate risk, PIMCO designed and developed our own Climate Macro Tracker. This tool monitors the broad momentum in climate change across key themes and scenarios, and measures the gap between real-world metrics and global climate goals.
- PIMCO’s Issuer Climate Risk Score assesses climate change risks for a wide range of relevant sectors and issuers. Within each sector, climate risk scores are divided into transition risks (such as tighter regulations or shifting market preferences; e.g., stricter emissions requirements in the auto sector) and physical risks (how hotter temperatures, rising sea levels, or extreme weather events affect critical assets and natural resources used by the issuer; e.g., land usage in the agriculture sector).
- Green bonds and other debt instruments geared toward sustainability are proliferating in the global marketplace. To allow for stronger differentiation among green bond issuers and help us prioritize investments in high quality, high impact green bonds, PIMCO created a proprietary Green Bonds Score system. Scores are based on assessments both prior to and after issuance, mapping them across a spectrum based on strategic fit (consistency between the bond’s objectives and the issuer’s business strategy), potential positive environmental impact, red flags, and reporting, resulting in PIMCO’s impact score for green, social, and SDG bonds. Our Green Bond Score helps us map the spectrum of potential investments across the “50 shades of green” of sustainable investing, a concept popularized by Bank of England Governor Mark Carney.
The insights from these tools are designed to empower portfolio managers to better manage and mitigate climate-related credit risks and align with the international commitments deemed relevant by PIMCO, such as the 2016 Paris Agreement targets. We explore climate change in the context of broader sustainability risks and endorse the UN SDGs as the holistic reference framework to assess these wide-ranging risks, such as biodiversity, water scarcity, human rights, and labor rights, in transition to a net zero carbon economy. We also support the Task Force on Climate-related Financial Disclosures (TCFD) and engage with issuers for enhanced corporate disclosure on climate change and the SDGs.
The portfolio management team of Scott Mather, Jelle Brons, Ketish Pothalingam, and Samuel Mary average over 20 years of investment experience, and each member has been critical in building PIMCO’s ESG and sustainable investment platform.
We invite investors to consider allocating a portion of their bond portfolios to the rapidly expanding climate bond market, particularly if their long-term objectives include targeting sustainability and driving the transition to a net zero carbon economy, as well as investment returns and thoughtful risk management.
1 Source: Haver Analytics as of 30 September 2019
2 Net zero economy and carbon neutrality: Net zero carbon dioxide (CO2) emissions is reached when human-made CO2 emissions generated are balanced globally by an equivalent amount of emissions absorbed from the atmosphere, e.g., by planting trees or carbon capture and storage technology. According to the Intergovernmental Panel on Climate Change (IPCC), the world’s CO2 emissions need to be lowered to net zero around 2050 in order to limit temperature rise to 1.5°C compared with pre-industrial levels and thus potentially mitigate the worst negative impacts of climate change.
3 Source: Bloomberg New Energy Finance as of 30 September 2019
4 The Paris Agreement is the global accord to limit the global temperature rise by year 2100 to 1.5°C–2°C above pre-industrial levels. The Intergovernmental Panel on Climate Change (IPCC) “Special Report on Global Warming of 1.5°C” estimates additional annual average energy-related investments to achieve that goal to be approximately $830 billion.
5 Our exclusion criteria for this category is based on available data that indicate that revenues derived from fossil-fuel-related sectors across the value chain do not exceed 10% of the total company turnover, with a definition including distribution/retail, equipment and services, extraction and production, petrochemicals, pipelines and transportation and refining, and the production or distribution of coal and coal-fired generation.