Feature ESG – Bonds
says. “Generic indices also adopt an ESG approach by applying the same recipe that can be applied to equities.” Around a third of fixed income ETFs in Europe were based on ESG indices last year, according to Amundi.
Picking a winner
“The direction of travel that a corporate or sovereign intends to take is important in a sustainable approach to fixed income investing,” says Giulia Pellegrini, a senior emerging market debt portfolio manager at Allianz Global Investors. When it comes to ESG, expectations from asset owners have stepped up, Pellegrini adds. “Climate and social issues have become more important for our clients since last year. As a result, we are keener to come up with options to satisfy that demand,” she adds.
Alongside its traditional debt funds, which include ESG inte- gration, Allianz has a range of stricter products that exclude certain names and it is developing an impact investing offering.
“That will be the new normal going forward,” Pellegrini says. “It is starting from a low base, so I would not call it main- stream. I would call it necessary, or clients will not talk to you.” Yet assessing a bond’s ESG credentials may not be as hard as it seems. “People separate equities and fixed income into differ- ent approaches, but in a lot of cases you are looking at the same companies,” says Madeleine King, who leads the investment grade research team at LGIM. “So, as much as each asset class has its idiosyncrasies there is a lot of commonality. “There is not that much differentiation in how we look at ESG for fixed income and equities,” she adds. King’s colleague Jonathan Lawrence, who is an ESG research specialist, says: “Irrespective of a bond’s label, investors are exposed to the balance sheet and cashflows of the issuer. There- fore, you are exposed to the same risks as when buying a nor- mal bond.
“When we construct a portfolio, it is important to invest in companies which are taking sustainability seriously, even when participating in the vanilla bonds of a good ESG compa- ny as opposed to buying green bonds of a weaker ESG company,” he adds.
This is a big issue when assessing the sustainability of a bond. “Not all green bonds labelled green are deserving of the label,” Nietsch says, explaining that they have decided not to invest in some green bonds due to concerns relating to the company’s framework. “We look for the project that the debt is funding to have credi- ble alignment with climate science and that the issuer is trans- parent about how they are using the proceeds. “You have to assess what an issuer is doing overall. Although you can get some comfort around a project that a green bond is
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funding, you have to be careful that other parts of the balance sheet are not being used to expand its overall emissions,” he adds. Reznick agrees that bonds should be assessed at the corporate level. “The labelling is important from a communications point of view, but it is about the companies you invest in that shows how the portfolio is indemnifying itself against the risk of climate change. “Green bonds are necessary but not sufficient – you need change at the corporate level, which has an impact on all secu- rities in the cap structure, not just project based. It can magnify the positive impact of companies change at the corporate level as opposed to the project-based level,” Reznick adds.
What’s it worth?
It is a question as old as the concept of sustainable investing and people are still asking it: does buying green mean making less money?
“There is always the question of who gets paid for being green - the investor or the company? asks Nietsch. “It is becoming reasonably established that there is a premium for issuing green bonds in that they tend to price a little tighter than non-green issuances. “That does not necessarily mean lower returns. We believe green debt can help companies become more resilient and we have not seen many green bond defaults. This debt can con- tribute to de-risking a company, so it can provide an attractive risk-return profile, which we believe, could enhance returns over the long term.”
When it comes to green bonds, Freedman sees a slight spread premium, or a ‘greenium’, to vanilla bonds, making it clear that he is talking low single digits.
“Labelled bonds are stickier capital,” he says. “There are less sellers during times of crisis, so they hold in better during less favourable periods for fixed-income markets.” There is a danger that investors could pay too much attention to yields, where there are other factors to consider. “The ques- tion of return from the bond asset class is more a question of risk. The higher the risk, the higher the return should be,” Guignard says. “There is no structural reason why green bond returns should be higher or lower than other bonds,” he adds. “It depends on the risk that is embedded in those bonds.”
The growth of the market shows that investors believe they can make an adequate return for the risk taken. “The majority of green bonds come to market priced at the same level as con- ventional bonds,” Gordillo says. “If they were more expensive in the primary market, we would not have the multi trillion- dollar market we have today. Only investors with an impact mandate would buy them.
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