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Climate Change: Credit’s Role in Decarbonizing the Economy

By Laurie King and Henrietta Pacquement

In the first episode of 2021, we are joined by Henrietta Pacquement, CFA®, Senior Portfolio Manager and Head of Investment Grade with the Credit Europe team at Wells Fargo Asset Management. She will provide insight on climate change, specifically how within fixed income, investing in corporate bonds—also known as credit—has an important role on the path to a net zero carbon future.

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Laurie King: I’m Laurie King and you are listening to On the Trading Desk®. I’m excited to begin our 2021 podcast series with a discussion about climate change, specifically how within fixed income, investing in corporate bonds—also known as credit—has an important role on the path to a net zero carbon future.

Today, I’m talking with Henrietta Pacquement, Head of Investment Grade with the Credit Europe team at Wells Fargo Asset Management (WFAM) and a Senior Portfolio Manager. Welcome to the program, Henrietta.

Henrietta Pacquement: Hello, Laurie. Happy New Year, and thank you for having me on.

Laurie: As we look back at 2020, many would prefer to forget the year altogether because of its many hardships. But there were positive things that happened, and one of them was the strong interest from investors in sustainable investing. What did you see happen with sustainable investing trends, especially in fixed income?

Henrietta: We’re seeing increasing interest in sustainable investing on the back of a variety of both public and private initiatives. This has been a hot topic in Europe for a while, with even the European Central Bank staking its intent to contribute to climate transition.

But we’re seeing now increasing interest from the U.S. investment community, as well. A good example of that is the New York State Comptroller DiNapoli’s statement in December, where he announced that the New York State pension fund will endeavor to become carbon neutral by 2040. Now this is a pension fund that has a firepower of over $200 billion.

So we’re also seeing increased interest outside of the realm of just equity, with corporate credit, in particular, being considered under a sustainability angle. And it’s long been thought that credit and corporate credit is the poor cousin of equity because investors don’t have voting rights. But events this year in 2020 have meant that credit asset owners and managers are realizing that they also have a seat at the table to influence corporate strategy from a sustainability perspective.

Laurie: And as we look into 2021, are there environmental and sustainable investing milestones that we can look forward to?

Henrietta: We’re hoping to see some big milestones reached, even in the U.S. early on in the new administration. This could be, for instance, the U.S. rejoining the Paris Agreement or attending the UN COP26 Climate Change Conference later in the year.

We’re also in a situation where, globally, governments have stepped in to support their economies that have been hard-hit by the pandemic, and this puts them in a unique position now to influence sustainable investments in years to come, should they wish to do so. And it does seem that the intent is there with countries like Japan, for instance, in Q4 last year joining the commitment to becoming carbon neutral in 2050.

Laurie: And just so I understand, how do climate change objectives fit within the broader environmental, social, and governance (ESG) objectives or sustainability objectives? I mean, is it a separate mandate that investors are seeking or just one way to do those other things?

Henrietta: I’d say it’s a particular focus, but it is part of the more generic ESG objectives that investors are addressing at the moment.

What we’re seeing, particularly in Europe, is a holistic approach with investors looking at whole portfolios and across asset classes. And yes, you can get ESG specialist mandates, and they might have more of a peripheral role in an overall allocation. An example here could be a specific investment in green bonds, for instance. But using that example, that is a small portion of the global fixed income universe.

To give you an idea, if you look at some of the green bond indices, for instance, they finished 2020 with a market size just over $600 billion, and that’s despite the size of that market doubling over the course of last year.

So really what we’re increasingly seeing and what we’re getting in terms of queries from clients is how to incorporate specific climate trends in their portfolios and to decarbonize their entire portfolios over time.

Laurie: Well, thanks for explaining that. And as you were just saying before, corporate credit investors realize they really have a seat at the table for this. Why do bonds have a particular role to play in decarbonizing the economy?

Henrietta: Climate risk is increasingly impacting corporate strategies. It’s affecting asset valuations, and we’re increasingly seeing it driving regulation.

Asset managers and asset owners need to be fully aware of the implications of climate change on their portfolios and how it can affect the values of their investments.

And fixed income is a large asset class. It’s often a significant component of institutional portfolios, and it’s an asset class that has considerable impact on corporate health and behavior. Firms need to access the funding markets to function, and they need to be able to issue bonds at attractive spread levels for them.

I think we’re also seeing both from the investment community and governmental body is an increasing awareness that climate needs to be an issue addressed and facilitated by financial markets. And here, credit offers the benefit of targeted investment. Credit offers a degree of finesse. You can aim funding at certain subsidiaries. You can facilitate the funding of specific uses of proceeds. So all of this means that credit is a key tool to facilitate climate transition going forward.

Laurie: And here at Wells Fargo Asset Management, can you tell us about recent developments in how climate change thinking can be embedded in portfolios via credit research?

Henrietta: So there are many approaches that can be used to embed climate change thinking into portfolios. It can include looking at the current state of companies. What is their carbon footprint? What is their carbon intensity? Are they sitting on fossil fuel reserves and, if so, what type? If a company produces energy, what is the mix of sources within that production? This is information that is increasingly becoming available to investors, and this is information that we’ve been adding to our corporate analysis over the years.

And I think what may be even more exciting there is assessing what the future looks like and what structural changes are going on—how different sectors are being affected. And this really is the area of research that we’ve been particularly focusing on, given the global credit research platform that we have at Wells Fargo Asset Management. And here, really our credit analysts are providing a forward-looking fundamental assessment of the companies that we invest in, and they form an opinion as to what is expected in terms of the company’s climate transition trajectory and what is the viability of that corporate strategy.

Laurie: So when you talk about the climate transition credit, it really refers to investing in companies that are helping the world transition to being carbon free, but it’s really how we’re targeting the credits or the issuers that are doing that.

Henrietta: Yes, that’s correct. And I think what we’re trying to do, as well, is to try and marry clients’ climate objectives with their financial goals, because that’s really the sort of challenge investors are facing at the moment.

So the type of approach that we’ve been working on with clients is inspired by the work done by the European Union on climate benchmarks to help navigate this challenge. So as you say, the aim is to encourage capital to companies to fund companies to change and be active participants in climate transition. And our belief is that it’s really necessary if we really want to make an impact in terms of reducing carbon emissions going forward. It can’t just be tilting a portfolio towards less carbon-intense sectors. It’s a question of moving the dial in sectors that are carbon emitters, be it utilities, transport, and construction, for instance. And that really is our approach in what we’re trying to do.

In particular, we’ve been talking with our clients about a climate transition framework that allows us to sort of achieve that dual goal of addressing climate considerations, as well as financial ones. So we’re looking at a fundamental approach, analyzing the companies we invest in, with a focus on their willingness and readiness to tackle climate transition.

So we’re not looking to exclude whole sectors due to their current carbon emission profile. We want to invest in companies that may not be there yet in terms of their carbon credentials now, but they have a credible strategy that they’re implementing and that aims to reduce carbon emissions going forward.

Now we do want to make our intent clear and show that a carbon intensity advantage is there from the start. So with that in mind, we look to design portfolios that have got an initial cap of carbon intensity of 30% below that of the portfolio’s benchmark. And in subsequent years, we’d be looking to decarbonize the portfolio over time with the objective of achieving carbon neutrality by 2050. And that’s associated with us actively engaging with the companies that we invest in to improve their climate disclosure, for instance, and also hold them to account on their carbon targets.

Laurie: Before we go, I wanted to ask you, in reading your bio, I saw that in addition to having earned a CFA designation, you have a master’s degree in astrophysics from Cambridge University. Can you tell us about that background and how it influences you today?

Henrietta: I’ve always had a keen interest on how things work and human creativity. And we’re at a stage where it’s going to take all our resourcefulness to evolve our economy to make it more sustainable. It’s going to be a considerable challenge, and we’ve seen what we can do over the course of this year—being able to develop a vaccine under a year and starting its rollout, for instance.

But climate transition is actually going to require a bigger technological change in years to come than even this feat. And working in the financial industry as a facilitator of that change over the next few years is really going to be fascinating and a critical element to get right going forward. So it fits nicely with my background. Admittedly, the astrophysics was a few years ago, at this point.

Laurie: Well, thank you for sharing that. It’s very interesting. And a last question on behalf of our listeners—do you have a final thought that you’d like to leave us with?

Henrietta: As we’ve discussed throughout this interview, we’re on a transformative journey that is going to affect a number of facets of our lives and sectors of the economy. Now with that in mind, we’ve started a series of research pieces that explore these impacts and explain our approach to analyzing companies in light of climate transition. These are available from our distribution channels. They’re a great way to introduce or expand listeners’ knowledge on climate transition and how it can impact their investment decisions. So I would thoroughly recommend that you take a look.

Laurie: Well, we’ll stop there for today, but thank you very much your insights today, Henrietta.

Henrietta: Thank you so much for the invitation today, Laurie.

Laurie: That wraps up today’s episode of On the Trading Desk. The climate change thought leadership pieces that Henrietta referred to can be found by visiting—the Insights section.

To stay connected to On the Trading Desk and listen to past and future episodes of this program, you may subscribe to the podcast on iTunes, Stitcher, or Overcast. Until next time, I’m Laurie King; take care.

Originally Posted on January 7, 2021 – Climate Change: Credit’s Role in Decarbonizing the Economy


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