Morgan Stanley IM: Fixed Income Engagement Strategy – Integrated, Insightful, Influential

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Morgan Stanley Investment Management (MSIM) Fixed Income has developed a targeted and thematic engagement programme on environmental, social and governance (ESG) issues. Our approach is fully integrated into our research and investment processes to identify opportunities for improved risk management and alpha generation through constructive dialogues with issuers, while encouraging them to pursue positive sustainability outcomes.

The Growing Imperative for Fixed Income Engagement

Fixed income investors have an important role to play in building a constructive dialogue with issuers and supporting them in pursuing positive sustainability outcomes while enhancing ESG disclosure and price discovery of the proper cost of capital when accounting for ESG risks. While engagement and stewardship have historically been an equity investor remit, we believe fixed income investors are uniquely positioned to have a positive influence on issuers for a number of reasons:

• The responses to some of the world's key sustainability challenges, such as climate change and access to basic services, are going to require large capital investments that are primarily financed via debt instruments, including with sustainability labels.
• The vast majority of primary market financing is conducted in the debt market rather than in the equity market, giving fixed income investors a regular and direct interface with issuers seeking their capital.
• The magnitude of debt financing requirements increases in stressed scenarios (such as the recovery phase after the COVID-19 pandemic), increasing the frequency of such issuer/investor interactions and their importance in shaping issuer strategy.
• Fixed income portfolios typically hold a large number of securities and a range of issuers, in contrast to the more concentrated nature of holdings in active equities portfolios, giving investors a broad scope of engagement opportunities.
• Fixed income investors are uniquely positioned to engage with and influence issuers that do not have public equity outstanding, including Sovereigns, Supranationals/Agencies, many High Yield companies and state- owned enterprises.

MSIM's Rationale for Fixed Income Engagement

Our Fixed Income engagement programme aims to achieve three main objectives:

1. Deepen our insight and understanding of the issuer and its sector;
2. Push for better sustainability outcomes; and, ultimately;
3. Capture alpha opportunities that may not be fully appreciated by the market.

Insights from the engagement process can therefore result in changes to our Credit Analysts' assessment of the issuer. This may in turn lead to a decision to participate in a new issuance, increase or reduce our existing holdings in outstanding bonds, or "watch-list" the issuer for our Sustainable Funds until more progress is made on the specific E, S or G issue of concern.

Finally, we strive to provide the same level of transparency that we expect of issuers. We therefore track and report our engagements on a quarterly basis, including their outcomes — i.e. whether they affected our investment strategy through the Analyst's recommendations or the Portfolio Manager's investment decision.

^{Risk Considerations}

^{ESG ratings are relative and subjective and are not absolute standards of quality. Ratings apply only to portfolio holdings and do not remove the risk of loss. There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.}