FROM PROCESS TOOUTCOME: SUSTAINABLE
INVESTING IN FIXED INCOME
RAPID EXPANSION TREND CONTINUESRUSSELL INVESTMENTS RESEARCH

From process to outcome:Sustainable investing in fixed income
Yoshie Phillips, CFA, Head of Fixed Income ESG Investing

Fixed income market practitioners are continuing to evolve their responsible investing practices
and expand product offerings to meet the dynamic sustainability outcome preferences of theirclient base. At Russell Investments, we are witnessing a rapid expansion in the techniques used
to further embed Environmental, Social, and Governance (ESG) considerations into day-to-day
investment processes. In this paper, we share some key ESG integration trends we areobserving amongst these practitioners. The topics covered include:
1. Active ownership in fixed income
2. Mapping the landscape
3. Data coverage availability
4. Engagement
5. Regulation
6. Reporting/Climate-risk measures
7. Product availability
8. Key portfolio characteristics
9. Surge of labeled bond issuance

1. Active ownership in fixed income
Before diving into the current landscape, it is helpful tocompare how broad responsible investing in fixed income
has evolved compared to equity investing. In our view, theprimary difference centres around the fiduciary duty andrights associated with active ownership (proxy voting andengagement) for equity strategies as well as the instrument
types associated with the fixed income market. Listed equity
investing includes publicly-traded companies, whereas the
fixed income market includes corporate bonds for public andprivate companies, and other market segments likesovereign, securitised credit and municipal bonds. Eachmarket is unique and requires its own approach.

The role of active ownership has grown as a major part ofresponsible investment practices. Fixed income investors areimportant capital providers and are increasingly taking
proactive roles in raising ESG-related agendas with bondissuers. Engagement activity has become a key source of
information to assess risk and return opportunities amongbond investors.
Fixed income investing is primarily focused on diversifying
and moderating the risks associated with equity investing –and this is true even for riskier securities such as high yieldbonds and emerging market bonds. Downside protection is
key to a successful fixed income strategy. Therefore, it is not
surprising that engaging on ESG issues has historically been
perceived as a risk mitigation exercise within fixed income
investing, rather than an exercise in the expression ofsustainability criteria.

Russell Investments / From process to outcome: Sustainable investing in fixed income/12. Mapping the landscapeThe term “ESG” can be interpreted and applied in different
ways and that can create confusion for many investors. We
prefer the term sustainable investing and believe that it
represents a continuum of products. What does sustainable
investing in fixed income mean?
We think about sustainable investing as consisting of bothprocess and outcome. This distinction helps us to classify
strategies into three categories: ESG Integrated, Sustainable
and Impact strategies. Process is concerned with howmaterial ESG-related information is integrated into a
strategy’s investment decision-making process. Outcomes
result from intentional efforts to incorporate and express
sustainable criteria in investment selection and portfolio
construction, often with a measurable result. These
classifications can be applied across asset classes, including
fixed income. That said, it can be difficult to draw a brightline between terms and classifications.
As well, products can bridge classifications and can shift overtime, so our focus is on providing a useful guide against
which individual products can be compared.

sustainable strategies to stand out and be differentiated inthis space, they need to go even further – in general, we
think that is a positive for investors.

We think about sustainable investing
as consisting of both process andoutcome. This distinction helps us toclassify strategies into three
categories: ESG Integrated,
Sustainable and Impact strategies.

3. Data coverage availability•

ESG data availability varies depending on the segment of
the fixed income market.

•

The corporate credit market has been the first to broadly
adopt sustainability integration. This is understandable
given that corporate bonds are the most similar toequities. Therefore, equity coverage has been moreeasily transferred over to the corporate credit market.

•

Within the corporate credit universe, investment-graderated corporate bonds tend to have more comprehensive
ESG data coverage than below-investment grade, or highyield bonds. The reason for this is that there are moreprivately held companies that are rated below
investment-grade, and therefore have disclosure
requirements that are less than those that are publicly
traded. That is even more true in the leveraged loan
market where privately-held companies account for
greater market share. Many leveraged loan managers
utilise their own ESG questionnaire to underlying loan
issuers since the third-party ESG data providers’coverage in this space is limited.

•

Mapping ESG-related information to a specific entity ischallenging in the fixed income market when comparedto equities. This is because any entities in fixed income
can issue debt at a holding, operational, and subsidiarylevel, with different seniorities, whereas stock is often
issued at a parent level. Therefore, ESG data coverageand cleaning is trickier since each entity level can havedifferent data coverage and business models.

•

ESG data coverage continues to expand withingovernment (sovereign) bonds, followed by municipal
and securitised markets, over the past few years. ESG
considerations in government (sovereign) bonds are also
inherently more complex. Assessing key material ESG
related information can be subjective, but the corporatebond market has a well-established framework under the
SASB Materiality Mapping. In contrast, the sovereignand other fixed income market segments lack suchmarket standards. Therefore, the outputs of ESG
assessments for sovereign bonds remain wide
depending on ESG data providers. Most fundamental-

Broadly•••

ESG integrated strategies incorporate material ESG
criteria into the investment process with the aim tobetter manage risks and improve the returns of aninvestment strategy. Material ESG issues involve a highlikelihood of such information impacting theperformance of the specific entity. Because the industry
has increasingly recognised the materiality ofenvironmental and social issues, many strategies today
can claim to be ESG integrated.
Sustainable strategies typically seek holistic ESG
outcomes using additional processes or sustainable
criteria, such as better climate risk management,
engagement focus and/or allocating a portion of funds
toward environmentally - and/or socially-minded
investment opportunity sets. The labelled bond, i.e.,
green bonds, allocation is greater for sustainablestrategies than traditional bond strategies. Whilesustainable outcomes are identified, the benchmark forthis category is still most often a conventional
benchmark, such as the Bloomberg Global Aggregate
Index.
Thematic/Impact strategies aim to generate specific andmeasurable positive sustainable outcomes for the
majority, if not all, of the portfolio. The opportunity set
for this category, meaning the range of investments
targeted, tends to be much narrower than sustainablestrategies and the benchmark can differ from a
conventional benchmark.

Given the increased focus from investors and other market
participants, we note that fixed income practitioners acrossthe board are increasingly aware of sustainability concerns.
Regulators, especially in Europe, are stepping in to try
standardising the “sustainability” frameworks, and for truly

Russell Investments / From process to outcome: Sustainable investing in fixed income/2based asset managers form their own ESG insights toassess materiality of ESG related information across allof the fixed income segments.
•

The securitised market offers a wide range of investment
opportunities, including mortgage-based securities(MBS), asset-backed securities, and commercial
mortgaged-backed securities, but this market segment
lacks industry standard best practices for ESG-related
analysis of the underlying securities. Some progress has
been made. For example, Fannie Mae launched newsocial scores for its single-family MBS in late 2022, andmany asset managers are coming up with their own
methodologies in this segment. That said, the lack ofadequate ESG data at the security level remains the key
challenge and a work in progress for this part of the
fixed income market.

In summary, each fixed income market segment has its own
challenges relating to data availability. Third-party ESG data
providers have ramped up in their efforts to extend theiroverall coverage, but in doing so, we have noted significant
use of assumptions and proxies to extend coverage to thosebond issuers who have not disclosed ESG-related
information. Therefore, while the overall market coveragemight have increased year-on-year, the underlying security
level analysis and quality of data requires careful scrutiny.

An explanation of government (sovereign)bond data challenges
Fixed income market practitioners continue to expand data
coverage and methodologies for ESG and climate-related
metrics. However, emissions data for sovereign bonds facemultiple challenges, including:•

Data availability and quality (i.e., some countries lackaccurate emission calculations), data gaps (i.e.,
incomplete data), time lags (i.e., lacks timely data) andmethodological differences (i.e., different methodologies
and assumptions used) among various countries.

•

When compared to corporate credit, government(sovereign) debt has a slower rate of change at thecountry level, given its decision-making process;therefore, investors need to be mindful of the timeline
associated with this. For instance, engagements withsovereign bond issuers require a longer investment
horizon than corporate bonds.

•

Government (sovereign) bond carbon calculation
methodologies also remain inconsistent among asset
managers. While many bond managers use productionbased emissions metrics, some practitioners haveargued that frameworks must look at consumption-based
methodologies.

•

Sovereign-level climate data includes climate data ofcorporations, which results in double counting.

•

Another challenge faced is how to normalise greenhousegas emissions (GHG) data. For instance, this could
include deciding whether to apply nominal GDP or GDP

per capita; both options can make a material differencein the calculated output.
•

Many governments set and enforce climate policies andregulations which offer forward looking indications, butgovernment regimes can change and there are often
huge time lags between making pledges and theirimplementation.

There are some developments underway to address thesechallenges, particularly under the Partnership for Carbon
Accounting Financials (PCAF), which was launched in
December 2022 to address reporting standard of financed
emissions for sovereign bonds with methodology options.
The Assessing Sovereign Climate-related Opportunities andRisk (ASCOR) project was launched at the end of 2023 withthe aim to aids assessing countries efforts towards climatechange. However, it will take some time for the industry as awhole to reach a consensus.

Third-party ESG data providers haveramped up in their efforts to extend
their overall coverage, but in doing
so, we have noted significant use ofassumptions and proxies to extend
coverage to those bond issuers who
have not disclosed ESG-related
information.

4. Engagement
For equity investors, active ownership is the use ofshareholder rights to implement or advocate for corporate
best practices to improve the long-term value of a company.
Active ownership often utilises engagement to seek its
desired outcomes -- engagement being direct dialogue
between an investor and the company in which they are
invested. As a result, the term ‘engagement’ has been amainstream investment concept in equity investing for sometime. Over recent years, we have observed that fixed income
practitioners are also embracing engagement practices.
There has been growing appreciation that bondholder
engagement activities provide more information about howbond issuers are addressing material ESG-related
information, which can positively impact risk and return
opportunities.
While bondholders do not have voting rights per se, as
capital providers to corporations, they do have a direct line ofaccess and communication to company management. The
global bond market consists of over $70 trillion of issuance,
making bond investors substantial capital providers.
Furthermore, many bond issuers are repeat issuers, meaning
they come back to the capital market regularly – an incentive
for companies to engage with bond investors.

Russell Investments / From process to outcome: Sustainable investing in fixed income/3In our Annual Manager ESG Survey, we ask market
practitioners to state how often they engage with underlying
companies in relation to ESG issues. Our findings show asteady increase in ESG-related engagement across all asset
classes, including market practitioners who invest in bondofferings. In 2023, 95% of participants reported that theyoften or always discuss ESG topics when they interface withcompanies in which they are invested; an increase from 91%
in 2021. Moreover, in 2023, direct company engagement
became managers’ primary ESG info source. The heightenedmarket interest in ESG considerations has led to many
underlying companies to becoming more amenable toproactively discussing ESG related topics. Therefore, while
the explicit limitation exists for bondholders who are without
proxy voting, the influential power of bondholders appears to
be expanding.
Successful bondholder engagement case studies include
increasing labelled bond issuance, greater transparency anddisclosure (especially among privately held companies),pressuring board membership composition for privately heldcompanies, and encouraging board adoption of net zero
initiatives. Via our Survey, we have observed a steady yearly
increase in the number of firms reporting that they document
and monitor ESG-related engagement outcomes; 78%
reported doing so in 2023. To demonstrate effective
bondholder engagement practices, it is important for any
strategy to establish a framework on how to prioritise theobjectives of specific engagement activities and identify tools
for monitoring and reporting on the outcomes.
We have observed that some strategies may leverage theirequity counterparts to increase influence when engaging
with the underlying companies. Other strategies which have
limited or no equity offerings may seek to partner with otherparties to increase influence through collaborative
engagement. As the importance of active ownership grows,
so will the consensus among investors to implement active
management methods across all asset types.
Market practitioners have a pivotal role to play in the quality
and success of stewardship actions – ensuring value-additive
conversations are happening between investment
practitioners and the companies in which they are invested.
As we move forward, standout approaches will be able todemonstrate clear methodologies, articulate a best practiceand demonstrate effective engagement practices throughtheir reporting.

Successful bondholder engagementcase studies include increasinglabelled bond issuance, greatertransparency and disclosure(especially among privately heldcompanies), pressuring board
membership composition for
privately held companies, andencouraging board adoption of net
zero initiatives.

5. Regulation
Regulators around the globe are playing a vital role in how
the investment industry is incorporating ESG practices.
European regulators have introduced the Sustainable
Finance Disclosure Regulation (SFDR) in an attempt toincrease the transparency and accountability of investmentsthat claim to have ESG or sustainability objectives. The SFDR
requires asset managers in Europe to disclose how
sustainability risks are incorporated into their investment
decision-making process. Additionally, the European
regulator has established a classification framework - EU
Taxonomy - to determine whether an economic activity is anenvironmentally sustainable activity. To help facilitate uptakeof this new classification framework the regulators, especiallyin Europe, are expanding the disclosure requirements. At thesame time, there is some push back around sustainability
regulations, especially in USA. The regulatory dispersions
are creating challenges for market participants around how
best to navigate in this dynamic landscape.
There is ever-growing global support to tackle climate risk,
and while Europe has led the way in regulations to address
ESG measures, there are signs that other regions, like theU.S. with the recent SEC climate disclosure rule in March
2024, are following a similar path to developing taxonomies
and standards. Increased regulations which focus ontransparency, disclosure and use of common language insustainable investing, assist in the global standardisation of
the ever-evolving ESG practices. At the same time, reportabledata gaps exist in the fixed income market around ESG
considerations. Bond investors are trying to comply withregulations despite the data not being readily available forcertain fixed income segments.

6. Reporting/Climate risk measures
The increased regulation on ESG disclosure obligations is
accelerating the demand for portfolio transparency andreporting for sustainable outcomes. Both regulators andasset owners are demanding greater transparency around

Russell Investments / From process to outcome: Sustainable investing in fixed income/4ESG considerations in portfolios through reporting. The
forms of ESG reporting continue to evolve and still vary byasset manager. Furthermore, each asset owner can havevarying preferences in the reporting of ESG content, adding
further complexity. Today, there is no standardisation in ESG
reporting in the fixed income market, and many asset
managers are still building the infrastructure required tooffer customised reporting.
With the global economy facing significant climate-related
challenges, there is growing interest to measure and reporton how a portfolio is facilitating the transition to a net zerocarbon economy. Third-party data providers continue toexpand their reporting capabilities and coverage around themeasurement of GHG emissions. Climate risk can besegregated into physical risk – referring to climate-related
hazards that can impact asset prices - and transition risk –referring to those arising from the shift toward a low-carbon
economy. The Task Force on Climate-Related Financial
Disclosures (TCFD) guidelines detail how to disaggregatetransition and physical risks, yet some of these risks arechallenging to quantify. The Partnership for Carbon
Accounting Financials (PCAF) has developed a methodology
to report emissions associated with financial activities.
At Russell Investments, we have committed to the Net Zero
Asset Managers Initiative (NZAMI) to support the goal of net
zero greenhouse gas emissions by 2050. The NZAMI, alongwith affiliated entities under the Glasgow Financial Alliancefor Net Zero (GFANZ), encourages all financial market
participants to evaluate the current status of their existing
portfolio offerings, their engagement activities toward net
zero, and forward-looking climate transition plans. Many
asset owners are increasingly interested in the transparencyof how the portfolios they invest in are aligned with the Paris
Agreement to address climate risk. Climate risk measurescontinue to expand and are key to the evolution insustainable investing.
Climate risk measurement methodologies in the fixed income
market vary from corporate bonds to sovereign bonds togreen bonds. For corporate bond allocations, many market
practitioners report carbon intensity normalized by sales –known as Weighted Average Carbon Intensity (WACI). Someof them have started to include financed emissions with theEnterprise Value Including Cash (EVIC), which incorporates
an underlying company’s total enterprise value, including
market capitalization and total debt. The TCFD recommends
WACI while the PCAF recommends using EVIC. We
recognize each methodology provides valuable insights withunique challenges. For sovereign bond climate metrics, manymarket practitioners report sovereign emissions per GDP and
per capita. For the green bond market, the focus of climate
risk measurement is on the use of proceeds rather than the
carbon emissions of the issuers who can be high carbon
emitters including utility companies. Estimating how muchcarbon emissions are avoided with green projects is anotherpopular reporting approach for green bond portfolios.
Options for broader sustainability reporting criteria continue
to expand, and on prominent categorisation is the United
Nations Sustainable Development Goals (SDGs). The SDGs
encompass a set of 17 goals designed to create a peaceful,sustainable, and prosperous planet for all people, and theaim is to direct capital towards investments that makepositive real-world progress towards achieving the SDGs.
While the SDGs provide a common framework in defining thecritical positive outcomes, it leaves much subjectivity inmeasuring and mapping underlying investments to certain
SDGs. For example, one methodology looks for revenue or
activities to map to SDGs while other methodologies try toestimate a positive minus negative impact by converting all
activities into asset values. Therefore, investors should be
mindful of how different methodologies can lead to different
impact outcomes.

Climate risk measurement
methodologies in the fixed income
market vary from corporate bonds tosovereign bonds to green bonds.

7. Product availability
Our research on sustainability-focused fixed income
strategies started over a decade ago when these offerings
were mostly limited to strategies investing into green bonds,
outside of exclusionary-oriented mandates. Today, asset
managers are trying to offer customised solutions to meet therange of client interests. In recent years, sustainableoutcome-focused fixed income strategies have expanded tobroader segments of the fixed income market. As mentioned
earlier, we segment these strategies into two types:
Sustainable and Impact.
Due to greater ESG data availability in the corporate bondmarket, many sustainable strategies focus on investment
grade credit. However, in recent years, sustainable fixedincome offerings have expanded to encompass high yieldbonds, emerging market debt, multi-sector/global bonds, andmulti-asset credit strategies. Here we share some of the key
findings for outcome-focused sustainability products thus far.
•Among preferences for sustainable outcomes, there is aclear trend towards strategies that emphasise climatefocused impact. Others have emphasised alignment withUN SDGs and broader sustainability goals.

•

With the growing market opportunity set for Green,
Social and Sustainability (GSS) bond issuance, moreproduct offerings are focusing on this market to offer
Impact strategies with transparency on how the use ofproceeds are impacting Environmental and Social
outcomes.

•

With the global economy facing significant climaterelated challenges and the energy transition remaining a
top investment priority for many clients, there is growinginterest in aligning portfolios with net zero anddecarbonisation goals. Net Zero targets in the fixedincome market are often applied in corporate and green
bond strategies.

Russell Investments / From process to outcome: Sustainable investing in fixed income/5•For Europe-based credit strategies aligned to Net Zeroframeworks, some strategies are starting to utilise a
Paris Aligned benchmark for a corporate bond strategy.

•

Because Europe has been at the forefront of green
finance and sustainable investing, it is no surprise that
there are more sustainability-focused bond instruments –like green bonds – in EUR-denominated currency.

•

Biodiversity outcomes, i.e., preserving and restoring
ecological systems, -- in the fixed income market islimited and very early stage. Ocean biodiversity is anarea within the wider biodiversity theme and addressedby a new bond category called blue bonds, which aredesigned to finance the conservation and sustainable
management of ocean and coastal resources. The blue
bond is essentially a very small subset of the green bondmarket. Biodiversity strategies are representative ofthematic investing and that might be more accessible inprivate or public equities where you can construct a
portfolio with a smaller number of securities. However,this theme is harder to address in fixed income portfolios
which tends to adopt broader diversification to limit
idiosyncratic risk.

8. Key characteristics of thesustainable landscape for fixedincomeLike in the equity space, we note that more sustainablestrategies are positioning themselves as mainstream
offerings with similar risk and return objectives to traditional
strategies. Unlike equity, fixed income contains a morediverse range of sub-asset classes, and so, where investors
are seeking to switch from more traditional strategies, they
will need to consider whether any key characteristics of thesustainable fixed income offerings differ.

Unlike equity, fixed income contains
a more diverse range of sub-asset
classes, and so, where investors areseeking to switch from more
traditional strategies, they will needto consider whether any key
characteristics of the sustainable
fixed income offerings differ.

benchmark. However, the tracking error for certain
categories of sustainable strategies, such as high yield,
emerging market debt and multi-asset credit strategies,
can be slightly higher than that of the traditional
portfolios against the same benchmark. This reflects theinfluence of products which seek to exploit a narrower
set of sustainable characteristics. In other words, thetracking error can increase when exclusion lists expand.
•

The implication of exclusion lists needs up-front
understanding. For example, the global high yield bondmarket consists of approximately 10% in the Energy
sector (~5% for equity MSCI ACWI), and many climatefocused high yield strategies will tend to avoid thesector. A meaningful weight divergence can cause aperformance dispersion, especially for a short-term
investment horizon.

•

In contrast, the return expectations for investment gradebond strategies, such as a Global Bond strategy
benchmarked against the Bloomberg Global Aggregate
Index, are more similar between traditional andsustainable strategies, with idiosyncratic risk playing aless dominant role.

Sustainable outcome•

As with equity investing, sustainability outcomes in fixedincome target positive environmental, social andgovernance impacts while generating financial returns.

•

Among sustainable products which seek to incorporate
certain sustainable outcomes, the outcomes may include:
a reduction of carbon emissions intensity, a predetermined level of minimum allocation in GSS bonds,
greater corporate stewardship through positive
engagement, exclusionary screening, and/or aligning aportfolio with UN SDGs.

•

Among Impact strategies, green bond strategies aim toachieve environmental impact through financing
environmental-focused projects, such as renewableenergy, energy efficiency, pollution prevention,
sustainable water, and green buildings. Other impact
bond strategies include applying Net Zero frameworks
into the corporate credit market to target carbon
neutrality by 2050. Examples of such frameworks
include the forward-looking target setting methodologyof the Paris Aligned Investor Initiative’s Net Zero
Investment Framework (PAII NZIF) and the Institutional
Investors Group on Climate Change (IIGCC)’s guidance
on Net Zero alignment.

Credit quality•

Because many sustainable strategies will exclude certain
segments of the investment opportunity set by design,
this can affect the level of overall credit quality.

•

For example, in a sustainable global bond strategy,
certain types of bonds, such as CCC-rated bonds andemerging market debt, typically have a more limited rolecompared to a traditional approach. Since these

Risk/return•

Overall, the tracking error (deviation in returns from thetraditional benchmark) for investment grade bondstrategies is similar between sustainable andconventional bond strategies against the same

Russell Investments / From process to outcome: Sustainable investing in fixed income/6excluded segments usually offer higher yields, manysustainable strategies look at other ways to bridge the‘yield gap’, such as adopting greater allocations to BBand B-rated bonds.
•

Therefore, we note that the average credit quality of themore sustainable oriented strategies can be slightly
lower than that of the flagship strategy for a similar
mandate for some strategies.

issuance was flat with 2022 full year issuance volume, but
this contrasts with the conventional bond issuance for 2023
which was down from the previous year in the face of higher
interest rate environments. The steady labeled bond issuancespeaks to higher demand for labeled use-of-proceed bonds.
The labelled bond market has four primary categories: green
bonds, social bonds, sustainability bonds and sustainabilitylinked bonds.
•

Green bonds aim to support the transition toward a low
carbon economy and are the largest component of thelabelled bond market. Green bonds are bonds issued bycountries or companies with the proceeds targeting
specific environmental projects and opportunities.

•

Social bonds focus on social impact, including affordable
housing, access to finance, and/or supporting small
businesses. Social bond issuance surged during the
COVID-19 crisis to finance economic support programsand the public health response.

•

Sustainability bonds target a combination of green andsocial goals. We have observed that such sustainability
bond offerings tend to link their investment
opportunities with the United Nation’s SDGs.

•

Sustainability-linked bonds (SLBs) have their coupons
linked to the issuers reaching specific environmental orsocial targets or key performance indicators (KPIs). If anissuer fails to reach these targets by a given date, thecoupon steps up or additional payment is due atmaturity.

Sector exposure••

The fixed income market encompasses multiple uniquesub-asset classes including government bonds,
investment grade corporate bonds, mortgaged-backed
securities (MBS), asset-backed securities (ABS),
commercial mortgaged-backed securities (CMBS), highyield bonds, leveraged loans, emerging market debt,
municipal bonds, and labeled bonds.
Sustainable strategies may seek to exploit certain
sustainable themes. For instance, the sector preference
might include tackling affordable homeownership in
MBS, energy and climate change in ABS, multi-family
affordable housing in CMBS, water and sanitation
through municipal bonds, and/or renewable energy andhealthcare innovation in corporate bond market.

Geographic exposure•

We note that many sustainable strategies tend to holdlower allocations to U.S. Treasuries relative to the
traditional benchmark, partly due to concerns about thelack of climate change action in the U.S. relative to othergeographies, i.e., Europe.

•

However, for a global strategy, we would note that it isdifficult to completely avoid large geographic sectors,
such as the U.S., given their substantial presence in the
global fixed income market. From a portfolio
construction perspective, such country allocations canplay a critical role in risk management and offeringliquidity.

•

Within certain market segments such as green bonds,
the non-U.S. allocation tends to be much greater giventhat non-U.S. issuers dominate the green bond market.

•

For emerging market debt strategies, there is a growing
notion that ESG-related assessments, such as climatechange, biodiversity, innovation, health, human capitaland governance, play a critical role in sovereign risk
analysis. ESG-focused strategies tend to have a defensive
bias with higher credit quality preference.

9. A surge of labelled bond issuance
Bonds with specific environmental and/or social objectives
are referred to as impact bonds or labeled bonds in the formof GSS bonds. The labelled bond market has grown in
issuance over the past few years. In 2023, labelled bond

The key to GSS bond investing is to understand how theproceeds are used and to monitor the actual versus statedobjectives.
Sustainability-linked bonds were newer instruments in theimpact bond market and remain relatively small in volume
when compared to other impact categories. Note that thesebonds are not tied to specific projects and can be used forgeneral corporate purposes. Some bond issuers favoured
sustainability-linked bonds due to this flexibility – they do nothave to be tied to specific projects and are not rigid in how
the proceeds are used, while still showing their commitment
to specific environmental or social outcomes. However,investors are challenging the relevancy and self-selective
nature of KPIs associated with SLBs and have shown apreference for GSS bonds over SLBs in more recent years. As
such, the SLBs issuance in 2023 declined.
The valuation of labelled bonds is also worth highlighting.
The surge in labelled bond issuance over recent years was
driven by strong demand. In fact, the spreads between
labelled and unlabelled bonds for the same company wereshowing a trend: labelled bonds were often slightly more
expensive than unlabelled bonds – referred to in the market
as the greenium. This was likely due to the proliferation of
ESG product offerings and ECB’s asset purchase programmethat prefer to invest in labelled bonds, creating a
supply/demand imbalance that influences price. That being
said, a greenium varies depending on the regions, i.e., Eurovs. U.S., and instrument type, i.e., investment grade bonds
vs. high yield bonds.

Russell Investments / From process to outcome: Sustainable investing in fixed income/7In fact, the spreads between labelled
and unlabelled bonds for the same
company were showing a trend:labelled bonds were often slightly
more expensive than unlabelledbonds – referred to in the market as
the greenium.

Russell Investments / From process to outcome: Sustainable investing in fixed income/8Summary and conclusions
The words ESG and Sustainable get applied in widely varying ways, and we believe it’s
important for all investors to understand what is meant by them in each context. Whenevaluating the sustainability features of strategies and products, we break down ESG or
Sustainable investing evaluation into a consideration of process and outcome. Moreover, whenclassifying sustainable strategies, we group then into categories classified as ESG Integration,
Sustainable, and Impact. ESG integrated strategies employ process expansion to incorporatematerial ESG criteria into the investment process with the aim to better manage risks andimprove returns of an investment strategy. Sustainable or Impact strategies will go a stepfurther, aiming for a particular outcome through integration and via portfolio construction.
These outcomes can be evidenced through case studies or by asset or portfolio characteristics.
The level of sustainable outcome expected for the Impact strategies is much more strenuousthan for the Sustainable strategies.
ESG specific information is increasingly available in the marketplace, yet this remains scarce insome areas of fixed income markets. The access to ESG-related data and the means to digest
such information into an investment process continue to evolve. Bondholder engagement has
become a key information source in assessing material ESG topics. As ESG related information
increases, asset managers are examining such information flows to identify material ESG
issues. Regulators are stepping in to set rules with the aim to enhance disclosures,transparency and accountability of ESG or Sustainable credentials. Reporting on ESG andclimate risk criteria is a major focus, and there has been considerable adaptation in the fixedincome market in the recent years, which will no doubt continue.
Responsible investing product offerings continue to expand around the globe into themainstream. Sustainable strategy options are broadening, even outside of the investment gradecredit markets. There is a clear trend towards emphasising climate-focused sustainableoutcomes. Many sustainable bond strategies aim to manage the portfolio’s risk and return
profile in a way that is similar to traditional strategies with the same benchmark. However,
portfolio performance may be impacted, especially for a shorter investment time horizon, whenmeasured against the same benchmark; this is often in situations when the targeted sustainableoutcome requires limiting the investment opportunity set. Impact bond strategies mostly focus
on Green, Social, Sustainable bonds. The labelled bond market continues to grow in issuance,with Green bonds offering greater linkage to positive environmental outcomes.
To conclude, the incorporation of environmental and social factors continue to expand in the
fixed income market as more strategies with sustainable outcomes are introduced into themarketplace. The role of engagement has gained ground among bondholders who want tobetter understand the potential risks and returns associated with ESG related information, while
seeking outcomes with sustainable goals where warranted. The methods of implementation
continue to vary, with best practice being dependent upon the asset type and practitioner;
identifying a common reporting mechanism still has a long way to go. As we move forward, thedevelopment of standout approaches will be essential to demonstrating leading implementation
methodologies, articulating a best practice, and defining informative metrics that are broadly
recognised by investors as effective implementations of ESG considerations.

Russell Investments / From process to outcome: Sustainable investing in fixed income/9

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