Fixed income drives new ESG focus

Considering ESG issues in a bond context is a growing area of interest from investors, who are currently contending with a market that looks uncertain and increasingly volatile, say Newton1 head of fixed income Paul Brain and portfolio manager and sector analyst Scott Freedman.

After a difficult year for fixed income investors across a range of assets, Brain believes government bond markets and selective emerging market investments could hold significant potential as credit markets tighten in 2019.

He anticipates that government debt levels as a percentage of GDP will continue to rise across most major economies and could 'crowd out' some other capital requirements. While overall market stress looks set to remain moderate this year, he also points to a potential rise in risk in credit markets.

"We think government bonds can do well and emerging market debt can do okay selectively this year but high yield and credit is where investors perhaps need to be cautious because company profits are reducing," he says.

Looking ahead, Brain predicts a tightening of liquidity for companies, with the risk of a slight uptick in credit defaults in the year ahead. He also has some concerns about the scale of consumer borrowing in areas such as car loans. On a more positive note, he adds rising interest in sustainable investing could provide a positive influence on fixed income markets.

Source: Bloomberg IMF as at December 2018
Source: Bloomberg IMF as at December 2018

The Newton Global Dynamic Bond strategy Brain leads invests across government bonds, emerging market sovereign debt, investment grade and high yield bonds.

Explaining the strategy he adds: "Ours is an absolute return strategy and our flexibility allows us to dip into high yield and emerging markets for a time then jump out again if we feel the credit story is deteriorating in order to smooth out volatility. That said, the performance of the four main markets we invest in can change quite dramatically over time and the difference between the best and the worst can be significant."

Commenting on the wider interest rate outlook and its current impact on the strategy, Brain adds: "We are in a phase where 10-year government bond yields are peaking and Fed fund rates have probably peaked as well and the US Federal Reserve now looks more likely to cut rates as we move into 2020. If US interest rates are not set to rise then emerging markets could perform well. With this in mind our strategy has selective exposure to emerging markets and we have added to allocation to high yield for now and raised our overall duration from 2.5 to 3.5 years to take account of changing markets."

Newton has long adopted environmental social and governance (ESG) procedures and also runs a parallel Sustainable Global Dynamic Bond strategy. Explaining its approach, Newton portfolio manager and sector analyst Scott Freedman says: "There is more and more evidence ESG issues have an impact on credit quality and bond returns.

"At Newton we assign specific ESG ratings to every company and also to every country. We also produce outlook scores in order to take account of the trajectory. Considering ESG issues within fixed income helps mitigate risk, which is so important to bonds."

According to Freedman, amongst certain 'red lines' against which Newton's Sustainable Global Dynamic Bond strategy is run, the tobacco sector is excluded – which is seen to have no level of safe consumption - and currently Brazil at a country level is excluded - amid the Newton team's concerns over its government's apparent enthusiasm for environmental deregulation.

1 Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA or the BNY Mellon funds.

The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed. [INV01609].

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Mellon was formed on 31 January 2018, through the merger of The Boston Company and Standish into Mellon Capital. Effective 2 January 2019, the combined firm was renamed Mellon Investments Corporation.