Public fixed income: New-frontier in ESG analysis shines a new light on municipal bond valuations
Investors have long turned to municipal bonds as a strategy to help generate tax-exempt income and diversify their portfolios. While our industry-leading approach to fundamental credit research is central to our municipal investment process, at Nuveen we believe there is opportunity to introduce nontraditional data to help measure environmental and social outcomes of municipal issuers, which in turn can help reveal relative value that is perhaps unseen by traditional credit research.
Recognizing this potential, but identifying the gaps in the market for environmental, social and governance (ESG) data and disclosure in municipals, we leveraged diverse data from sources such as the Environmental Protection Agency and Federal Bureau of Intelligence to understand underlying ESG characteristics of muni issuers. Using unstructured data sets that are typically used in a nonfinancial context, we applied a proprietary methodology to pinpoint municipal issuers leading on ESG outcomes. The analysis uses sector-specific ESG factors that align with the objectives of the U.N. Sustainable Development Goals (SDGs), a global agenda that seeks to drive a more sustainable, equitable future. The chart below offers a glimpse of some of the material factors used to assess ESG-related outcomes for cities, hospitals, electric utilities and water/ sewer issuers.
In the public power sector, for example, we score issuers on their overall management, reliability, affordability, energy conservation efforts and inclusion of renewable energy in their generation portfolio. For cities, we weigh data related to air quality, housing costs, access to transit and safety. For hospitals, quality of care, patient satisfaction and affordability of care are key ESG metrics used in our assessment. An illustrative example of how we weight ESG factors to develop an issuer score can be found below.
Scrutinizing municipal bond issuers through an ESG lens may reveal relative value.
A tale of two (surprisingly different) citiesIntegrating nontraditional data sources into the investment decision-making process helps us assess the ESG performance of municipal securities and allows us to apply an innovative lens with which to address relative value and to manage risk. Even though a selection of municipal issuers might have similar credit ratings, their ESG profiles could diverge significantly. Strong ESG performance and management practices can help with head-to-head comparisons and can be an indicator of future credit quality.
For example, two cities in California appear similar when assessed using standard valuations of credit metrics and ratings. And, due to exceptionally strong in-state demand for California municipal bonds, both munis are priced very aggressively compared to those from elsewhere in the United States. However, by harnessing a range of data in an ESG analysis, we may detect value that cannot be observed through standard analysis alone. This is demonstrated in the example to the left, in which the cities have similar credit ratings, debt and per capita income. However, higher ESG performance in air quality, housing affordability and crime rates make the security California City 1 stand apart.
We are only beginning to test how nontraditional data-sets will transform our ability to see and measure the underlying factors that contribute to municipal bond issuers and other sub-asset classes in which Nuveen invests. We will continue to refine our methodology as new data sources emerge and existing data becomes more granular. This capability strengthens our ability to apply an additional lens to public fixed income—bringing new opportunities to light.
Investing involves risk; principal loss is possible. There is no guarantee an investment’s objectives will be achieved. An investment which includes only holdings deemed consistent with applicable Environmental Social Governance (ESG) guidelines may result in available investments that are more limited than those that do not apply such guidelines. ESG criteria risk is the risk that because the criteria excludes securities of certain issuers for nonfinancial reasons, an investment may forgo some market opportunities available to those that don’t use these criteria.
The investment advisory services, strategies and expertise of TIAA Investments, a division of Nuveen, are provided by Teachers Advisors, LLC, and TIAACREF Investment Management, LLC.
Nuveen Real Estate is a real estate investment management holding company owned by Teachers Insurance and Annuity Association of America (TIAA).
Nuveen Real Estate securities products distributed in North America are advised by UK regulated subsidiaries or Nuveen Alternatives Advisors LLC a registered investment advisor and wholly owned subsidiary of TIAA, and distributed by Nuveen Securities, LLC, member FINRA.