Asset Management

Performance with Principles: Aligning Fixed-Income Investing with Social Values

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Socially responsible investing (SRI) – which takes into account environmental, social and corporate governance criteria – represents a rapidly growing and increasingly accepted approach to investing. Over the 15-plus years that SRI-based strategies have been tracked, growth in assets under management for such strategies has far outpaced the growth of conventional strategies. For example, total assets invested using one or more SRI strategies climbed above $3 trillion in 2010 (the latest year for which data are available), up 380% from 1995. By comparison, conventional assets grew 260% during the period, according to the Forum for Sustainable and Responsible Investment.

Article Highlights

  • SRI fixed-income strategies aim for competitive fixed-income investment returns.
  • Investors can align their portfolios with their social values.
  • There are a number of developments under way that may help drive supply and demand for SRI fixed income.
  • TIAA-CREF is one of the largest managers of socially responsible fixed-income assets.

As the industry has matured, SRI has expanded beyond equity investments in public companies into other asset classes. One particularly exciting area of development is fixed-income investing. TIAA-CREF has long been involved in fixed-income SRI but the industry in general has been slow to offer this option to investors. Of the 480 U.S. domiciled socially conscious funds covered by Morningstar, only 61 are categorized as fixed income; adjusting for multiple share classes, the number dwindles to 30. However, the number of fixed-income SRI funds is likely to grow quickly as asset managers look to satisfy stepped-up investor demand for SRI options, and as investors come to understand the unique investing opportunities that fixed-income SRI offers.

In this article, Stephen M. Liberatore, CFA, Managing Director and fixed-income portfolio manager for TIAA-CREF, offers insights into SRI fixed income and why now is a great time to consider aligning personal values with socially responsible fixed-income products.

What is unique about socially responsible fixed-income investing?

Fixed-income investments can provide financing for a variety of projects and companies that meet environmental, social and corporate governance (ESG) criteria. Through investments in publicly traded fixed-income securities, investors can support projects such as renewable energy, natural resources, community and economic development or affordable housing. For example, an investor could buy a municipal bond that funds a hydroelectric project, or a bond from the Department of Housing and Urban Development that funds inner-city development.

How does TIAA-CREF identify SRI fixed-income investments?

Our SRI fixed-income strategies seek to maintain a double bottom line, providing competitive fixed-income investment returns while offering investors the opportunity to align their portfolios with their values. The first step of my investment process involves evaluating the macroeconomic environment and its impact on fixed-income market fundamentals. I derive my overall strategy from this analysis and identify opportunities in the eligible investment universe, established by our ESG guidelines, to construct the portfolio.

ESG criteria are established at the portfolio level for all of our SRI fixed-income strategies. Our overriding goal with these guidelines is to strike the appropriate balance between the ESG expectations of our investors and the investment opportunities we need to maintain good performance. Although the ESG criteria vary between security types, our general approach is to choose those investments that are “best in class” in these criteria. For example, for corporate bonds, our process favors public companies that are strong stewards of the environment, devoted to serving local communities and society generally, committed to high labor standards for their own employees and those in their supply chains, dedicated to producing high-quality and safe products, and committed to managing their companies in an exemplary and ethical manner.

What is TIAA-CREF’s experience with SRI fixed-income investing?

TIAA-CREF is one of the largest managers of socially responsible fixed-income assets, with approximately $5 billion in SRI fixed-income mandates. We’ve also been doing it since 1990, longer than almost any other institution. During this time, we’ve assembled a deep bench of talent that is continually investigating new products, new ideas and new thinking around applying ESG criteria to fixed-income markets.

What is proactive social investing (PSI)?

We define PSI as investments in publicly traded fixed-income securities that provide competitive risk-adjusted return potential alongside clear social and environmental benefits and outcomes. We’ve organized our PSI investments around four themes: affordable housing, community and economic development, renewable energy and climate change and natural resources. We maintain a 10% target for PSI within SRI fixed-income portfolios, with all investments subject to the same relative value framework.

Since 2007, we have made proactive social investing part of our SRI fixed income strategies. From a performance perspective, we seek incremental returns by identifying PSI opportunities that are not included in our benchmark and are not widely followed. The independent analysis necessary to evaluate these investments aligns with our core investment strengths of identifying relative value through fundamental credit analysis. TIAA-CREF’s brand and size also give us a competitive edge in finding these investments: Since we are well-known in the market, we are presented with many primary and secondary market opportunities, so we get to consider the full range of available securities.

What is a specific example of a PSI investment?

For instance, we took a first mortgage position on One Bryant Park, an office building located in New York City, which is the first platinum Leadership in Energy and Environmental Design (LEED)-certified office building in the U.S. In order to secure the platinum designation, the building was deemed to have been constructed in a very environmentally friendly and sustainable manner. We also have a first mortgage position on the largest solar project in the U.S., Topaz Solar Farms.

Our PSI approach is global in nature, as some of the projects we invest in have a broad international reach. In early 2012, TIAA-CREF invested in “green bonds” sponsored by the International Finance Corporation, a member of the World Bank Group. These bonds provide capital for renewable energy and other projects that serve to mitigate the impact of climate change in developing nations.

Do you think investors will see more fixed-income SRI funds?

Yes. Given the investor demand, we expect to see many more strategies in the market. According to the Forum for Sustainable and Responsible Investment, 84% of plan sponsors predict that the demand for SRI options will increase or remain steady over the next five years. The expansion of SRI funds across asset classes will provide new ways for investors to invest in a broadly diversified portfolio that is consistent with their values, offering access to a pool of fixed-income securities such as agency debt, asset-backed securities, commercial mortgage-backed securities, corporate bonds, mortgage-backed securities and municipal bonds.

Are there any market trends that could have an impact on the space?

There are a number of developments under way that may help drive supply and demand for SRI fixed income. The U.S. market has generally been slower to incorporate ESG criteria than places like Europe, which, for example, already has established a competitive market for trading carbon emissions. But gradually sentiment is shifting in the U.S., and that is being reflected in new legislation and regulations. For example, in August the federal government finalized new fuel-efficiency standards for U.S. cars and light trucks, and many states have begun to enact renewable energy requirements in their jurisdictions. These trends favoring higher environmental standards definitely point to support for SRI investing.

What are the most exciting developments in the space today?

What’s really exciting is the momentum that’s building for SRI fixed income as more and more people want their money managed in a socially conscious manner. And as that demand accelerates, more issuers of fixed-income securities across more sectors are stepping up. Increasingly, issuers are coming to us, and the fact that our experience, size and track record allows us to play a market leadership role and help shape the market going forward is significant. We usually have two meetings a month with different prospective issuers of SRI fixed-income securities who want to discuss how to approach such an offering, how to structure the security, and what characteristics are needed to satisfy demand. The ability to play a role in the continued development of the market is truly exciting.

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