Finding Fixed-Income ESG Investments for Retirement Plans

Fixed income is important for defined benefit plans and defined contribution plan participants, so how can plan sponsors incorporate investments focused on sustainability?

Sustainable investing has become more important to all types of investors in the past few years. And now, many in the retirement plan industry expect plan sponsors will include more environmental, social and governance (ESG) investments in their plans since the Department of Labor (DOL) has issued a proposed rule that is more amenable to ESG investments in retirement plans than regulations issued by the previous administration.

Much of the focus on ESG investing has been on equity investments. However, defined benefit (DB) plan sponsors following a liability-driven investing (LDI) strategy allocate heavily to fixed income, as do defined contribution (DC) participants who are nearing retirement. Other DC plan participants, even those in target-date funds (TDFs), also invest a portion of their accounts in fixed income for diversification.

In a paper, “An Asset Owner’s Guide to Fixed-Income ESG Integration,” Josh Palmer, head of fixed-income ESG research at Willis Towers Watson in London, says one-third of all U.S. assets under professional management now use sustainable investing in their strategies. He notes that fixed-income ESG investments are already on the market, and the number of such funds continues to rise.

He says plan sponsors can look at investment labels and how they are marketed to find options, then do their due diligence to make sure those choices are appropriate. They can also engage with managers that run non-labeled ESG products with the aim of improving their ESG reporting. This will enable them to see how they are integrating ESG factors, if at all.

Plan sponsors can find green bonds, corporate debt issued by sustainable companies and debt with proceeds used for sustainable projects, Palmer says. “The U.S. is one of biggest issuers of green debt,” he says. “There is green infrastructure debt and green real estate debt—for example, financing the construction of offices with a low carbon footprint.”

Palmer adds that green bonds are more common in DC plans because these investments require lower management fees and are more liquid.

“There are labels on ESG fixed-income investments as there are for ESG equity investments,” says Brendan McCarthy, head of defined contribution investment-only (DCIO) at Nuveen. “For example, one of our top-selling and top-performing ESG fixed-income investments is our Core Impact Bond Fund.”

The Willis Towers Watson paper notes that the “ESG integration framework for fixed income has historically been opaque, either overly reliant on an equity model or not specific enough on what ESG metrics are relevant for bonds.” It says the diversity of the asset class, which includes corporate bonds, sovereign bonds, securitized credit and private debt, requires plan sponsors to take a nuanced approach to ESG investing.

The paper says asset owners’ questions for bond managers should include:

  • Does the manager have a framework to assess ESG risks?;
  • How does the manager integrate ESG approaches to add alpha (as exclusionary approaches could be limiting)?;
  • Similarly, does the manager create its own ESG ratings, or use an external provider (which may be less robust)?;
  • Does the manager seek to benefit from lack of detailed ESG coverage on specific issues/issuers (acknowledging this may be short-lived as more managers expand capabilities)? Has this “ESG alpha” been isolated and are there any examples to support this?;
  • Are there dedicated fixed-income corporate ESG resources? If not, what overlap exists with equity ESG analysts and how are the gaps filled?; and
  • Have all relevant fixed-income analysts and portfolio managers received sufficient ESG training?

Looking at ESG Fixed-Income Investment Managers

“The way plan sponsors can find [ESG fixed-income investments] is through sustainability-oriented manager due diligence,” Palmer says. “That’s how we find sustainable investments in fixed income.”

Palmer explains that fixed-income managers might provide reports with examples of how they’ve been investing sustainably, their sustainability metrics and the average ESG score of their portfolios. In addition, a manager might have separate sustainability targets—such as reducing emissions over time—in creating allocations to investments with real-world impacts. Managers also might have exclusions in place, he adds, and their sustainability scorecards could include a positive screen strategy in addition to excluding bad investments.

“We assess transparency, risk metrics and portfolio ESG scores, as well as manager-level ESG scores,” Palmer says.

In addition, plan sponsors and their consultants can look at manager engagement.

“We look at engagement reports from managers, which provide a summary of all engagements with issuers and other stakeholders,” Palmer says. “That helps ensure a manager is an active investor and a good steward of capital. It’s taking the extra step to make sure investments are being managed well.”

Evaluating ESG Fixed-Income Investments for DC Plans

McCarthy says sustainability efforts can be as impactful, if not more so, within fixed-income investments as they are within equity investments. He says it is prudent for DC plan sponsors to look at ESG approaches within fixed-income investments and how they can benefit and mitigate risk for participants nearing or in retirement.

McCarthy suggests that, to identify the universe of available fixed-income ESG investments, DC plan sponsors should enlist the help of an investment consultant to ensure they can incorporate ESG benefits into portfolios in a prudent way.

“ESG factors can improve performance and reduce risk,” he says. “But it is important that the evaluation of ESG investments is done properly, and a consultant can help.”

Unlike equity investments, finding successful fixed-income investments is more about avoiding losers than picking winners, McCarthy explains. So screening for ESG in fixed-income investments can help mitigate downside risk by adding another assessment of business risk. “These areas of risk are not often identified with traditional financial analysis,” he says.

McCarthy says the evaluation of fixed-income investments should always start with investment performance. Even if they’re using an investment consultant, plan sponsors need to understand an investment manager or issuer’s process.

“Plan sponsors need to ensure they are looking under the hood. Ask, ‘what does the investment mean by ESG or sustainable?’” he says. “Sustainability is a subset within ESG that has two fronts: Environmental relates to climate change, renewable energy, etc.; and social relates to community, such as help providing affordable housing. And, as a fiduciary duty, plan sponsors must assess strategies within an investment portfolio for pecuniary effects.”

McCarthy adds, “We will not sacrifice performance or distort risk in pursuit of impact. It is important for plan sponsors to understand they can invest sustainably in a responsible manner and still put investment performance and risk management first.”

McCarthy says it is also key to understand the philosophy of the investment manager and the pecuniary impact of that philosophy. “In light of the DOL rule back and forth, plan sponsors can’t alleviate themselves from focusing on good investments for the plan,” he says.

As with any other investment, McCarthy says, plan sponsors should document the process for investment selection. In addition, for DC plan sponsors, it is important to effectively communicate to employees about what the product means. “ESG is more understood than it used to be, but there are still some misunderstandings, so plan sponsors need to educate employees,” he says.


Palmer notes that greenwashing can be an issue. S&P Global describes greenwashing as “making exaggerated or misleading environmental claims, sometimes without offering significant environmental benefits in return.” However, S&P says there’s little evidence of the practice among sustainable investments.

Palmer says European officials are developing regulations to protect investors from greenwashing. “If greenwashing becomes an issue in other markets, we might see more regulations,” he says.