07 Oct 2024
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Municipal Bonds
Innovation in ESG municipal bond investing
Nuveen developed a proprietary ESG scoring methodology designed to evaluate a municipal issuer’s potential contribution to positive ESG outcomes relative to their peers. Using a comprehensive approach, Nuveen seeks to help clients achieve the investment benefits of municipal fixed income while aligning with their values and helping to provide positive outcomes for our communities.
ESG integration is underdeveloped in the municipal industry
Over the past decade, the integration of environmental, social and governance (ESG) factors into investment analysis and decision making has become common in public equities and corporate taxable fixed income. ESG integration into the municipal bond market, however, remains underdeveloped.1
We believe this disparity exists for a few reasons. First, the municipal market lacks third-party ESG ratings from data providers, who offer valuable inputs into the equity and taxable fixed income markets. The sheer volume of municipal issuers — approximately 50,000 — and the shortage of ESG disclosure by these municipal issuers contribute further to the gap. As a result, very few municipal strategies explicitly integrate ESG factors or ratings, and those that do tend to focus on social and green bonds.
Another factor may be an underlying belief that municipal bond investments are inherently ESG oriented, since most municipal issuers finance public services like transportation, sanitation infrastructure, schools and utilities.
However, like any industry or asset class, municipal issuers may vary significantly as to how well they are governed and how constituents experience environmental and social outcomes. We believe that considering ESG factors in our municipal strategies may help encourage these positive outcomes.
Nuveen has a history of leadership
Nuveen’s long history and leadership in the municipal bond market, coupled with our responsible investing expertise, prompted us to develop a rigorous in-house, data-driven methodology to assess municipal ESG leadership, tailored to individual municipal bond sectors.
At the same time, we actively participate in organizations that have shaped the responsible investing field over the past five decades such as the Principles for Responsible Investment (PRI) and the Global Impact Investing Network (GIIN). We have advised on white papers with the UN Principles for Responsible Investment’s Sub-Sovereign Debt Advisory Committee, the Government Finance Officers Association (GFOA), the California Debt and Investment Advisory Commission (CDIAC) and the California Green Bond Market Development Committee (CGBMDC). We also participated in an ESG disclosure pilot program for municipal issuers with CDP (formerly Carbon Disclosure Project) and advocated for increased ESG-related disclosure in issuer documents to the Municipal Securities Rulemaking Board (MSRB).
By participating in industry groups focused on responsible investing as well as traditional public finance, Nuveen seeks to bridge the gaps in conversations that have historically left ESG out of the municipal market. Through these partnerships, Nuveen is helping to advance ESG disclosure and best practices in the field, bringing focus and client interest to this growing area.
Proprietary methodology identifies bonds that may deliver positive outcomes
Nuveen’s ESG municipal scores — developed in 2018 by senior members of Nuveen’s municipal research team and responsible investment team — seek to analyze a municipal issuer’s potential contribution to positive ESG outcomes relative to peers. Examples of positive ESG outcomes may include, but are not limited to, improvements in education, public health, housing affordability and public infrastructure. The team designed sector-specific models that consider relevant ESG factors and weighting criteria unique to each sector. The models are intended to score a meaningful portion of municipal issuers.
These scores are made available to research analysts and portfolio managers for consideration in the investment process. For client mandates with explicit ESG investment parameters, the scores are used in portfolio construction, as described more fully below.
Scoring identifies ESG leaders by sector
For each municipal issuer, sector-specific ESG factors are weighted and scored using a proprietary methodology to determine the overall ESG municipal score.
The weighted average of the ESG factor scores is aggregated to create an overall ESG score on a range of 1 to 5. A 1/5 represents issuers that are least/most likely to contribute to positive ESG outcomes relative to peers. Municipal issuers scoring 3 and higher are considered ESG leaders and typically represent 50% to 65% of our regularly traded municipal holdings.2 Issuers scoring a 1 or 2 are considered ESG laggards. For example, Figure 1 shows how scoring would work in the hospital sector based on quality of care, patient satisfaction and affordability of care.
ESG laggards are generally not eligible to be included in municipal portfolios with explicit ESG investment parameters unless the bond has a qualifying use of proceeds with positive environmental or social impact (see the thematic use of proceeds section), or the bond otherwise meets the investment criteria of the client mandate.
Aligning municipal bonds to the UN Sustainable Development Goals
We believe the United Nations Sustainable Development Goals (SDGs), as shown in Figure 2, serve as a guide for how municipal bond investments may translate to real-world, positive outcomes. These 17 interconnected goals are designed to be a “blueprint to achieve a better and more sustainable future for all.”3 Underpinned by 167 development targets, the goals were agreed to by 193 governments in 2015 to go through 2030.
As part of our proprietary ESG scoring methodology, we developed an SDG alignment framework that aligns sector model factors to the underlying targets of specific SDGs. SDG-alignment indicates if an investment is directionally consistent with or linked to the overarching theme of one or more of the SDGs. Issuers with an aggregate ESG score of 3 or higher are generally aligned to the sector-relevant SDG.
Thematic use of proceeds bonds add to diversification
For strategies with explicit ESG investment parameters, we also have the capability to invest in municipal bonds with a use of proceeds intended to directly finance projects with environmental or social benefits. These bonds typically make up less than 15% to 20% of these portfolios, but may allow for diversification. They could have green, social or sustainable labels assigned by the issuer or could be unlabeled.
Unlabeled thematic bonds are identified through our active fundamental research process by reviewing the offering documentation to determine whether the projects are making a positive impact. For example, as shown in Figure 3, proceeds may be used for the construction or maintenance of water sanitation facilities. Social and sustainability bonds might support affordable housing development, the creation of education facilities or health care in low-income communities.
We also evaluate thematic use of proceeds by leveraging market standards such as the International Capital Markets Association’s SDG framework.
Applying ESG scores: Real-world examples
The consideration of ESG factors can be an important input when constructing portfolios. Municipal issuers with similar credit ratings may exhibit divergent ESG profiles.
Figure 4 compares the credit quality and ESG considerations of two city general obligation bonds. While they maintain relatively similar credit metrics and ratings, their ESG profiles (as measured by Nuveen’s proprietary ESG scoring methodology) are very different. Atlanta excels relative to its peers in accessibility to mass transit, clean air quality and spending on services including housing, education, public safety, social services and sanitation, which align to the underlying goals of sustainable cities (SDG 11). Conversely, Las Vegas lags relative to peers in safety, clean air quality and housing affordability.
Leveraging this analysis, an ESG leader may provide a more positive intended outcome (e.g., a higher quality of life) relative to its peers.
ESG factors serve as an additional evaluation tool
Municipal bonds are known for generating tax-exempt income and enhancing portfolio diversification, but they can also provide a way for investors to make positive contributions to society through their investments. Adding an ESG focus means analyzing sound environmental, social and governance practices by municipal issuers, which may result in positive outcomes for their constituents.
Nuveen brings together market-leading responsible investing and municipal investment capabilities by evaluating ESG scores at the municipal issuer level. Employing ESG analysis provides an additional lens with which to view the portfolio, helping clients seeking to align their investments with their values.
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Endnotes
Sources
1 Summary of Responses to the MSRB’s Request for Information on ESG Practices in the Municipal Securities Market, August 2022
2 Nuveen, Perform/CreditScope, 20 Sep 2024
3 United Nations Sustainable Development, https://www.un.org/sustainabledevelopment/sustainable-development-goals/
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
Important information on risk
Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments. This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well.
Nuveen, LLC provides investment solutions through its investment specialists.
This information does not constitute investment research as defined under MiFID.
Nuveen considers ESG integration to be the consideration of financially material ESG factors within the investment decision making process. Financial materiality and applicability of ESG factors varies by asset class and investment strategy. ESG factors may be among many factors considered in evaluating an investment decision, and unless otherwise stated in the relevant offering memorandum or prospectus, do not alter the investment guidelines, strategy or objectives. Select investment strategies do not integrate such ESG factors in the investment decision making process.
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