ing, which means there are limited avenues of capital available to them. Norway’s sovereign wealth fund has said that 60% of the greatest fossil-fuel emitters globally are not listed. So fixed income has, and should take upon itself, the power to improve.
PI: Are investors sacrificing return by investing in an ESG-compliant bond? Gull: It goes back to fundamental credit analysis. We are long-term bondholders because of our long-term liabilities so buying the highest yielding bond on day one may not be the best thing to do because you may not get that yield. That is what you are consider- ing when you integrate ESG into your credit assessments. Something might yield a bit more because there is uncertainty about the way a risk is developing. If you think that risk is under- priced, you probably shouldn’t be buying that bond. We can debate whether bonds in the energy market are pricing in ESG risk. There might be higher carbon taxes or people might sell the bonds because they want to make a social impact. If those trends have further to go you will be giving up a bit of day one return by buying something else, but long term you get a better return. For us it is about the long-term return and making sure that it is there. If you are managing your risk, you will not necessarily buy the highest yielding bonds, but buy the bonds that you think have the lowest long-term risk and ESG is part of that. It’s not as straightforward as giving up return. It’s about what you think the long-term return will be. O’Neill: Not in our view. There is also a key question of downside protection here. Many pension schemes have been investing in buy and maintain credit portfolios for some time. If you are hold- ing to maturity you are focused on that long-term trajectory. You do not have the ability to trade out if a risk crystallises in the short term, unless covenants are breached.
PI: Green bonds have their critics, but is it easier to assess their sustainable credentials than for a mainstream bond? Freedman: It comes down to fundamental bottom-up analysis; does the risk/reward makes sense? A couple of years ago, a Ger- man-listed wind turbine assembler launched a green bond, but two years later it defaulted. Just because it is green does not mean that you buy and forget about it.
It is important to get a second party opinion to make sure there is an alignment with the green bond principles, to ensure that the use of proceeds is appropriate. But the buyer must also ask if the use of proceeds matches their own philosophy. Pickering: This is an area where I rely heavily on my investment consultant to make sure that what I am buying has not been given a label.
We have to look at the underlying assets that we are putting peo- ples’ money into. Responsible investors need to make sure that the whole concept is not devalued by rogues in the marketing department saying: “Call it green and it will sell.” That is not in my interest and is not in the asset managers long-term interest either. Freedman: The lead of a European syndicate for a large investment bank told me that the order books for green bonds are 20% larger than for non-green bonds. We are not mandated in any way to accept a lower return just because it’s green. Maybe in a risk-off scenario the spread is hold- ing better than non-green because there are fewer sellers, but we will not buy something priced more expensively just because it is green.
Nummela: The green bond universe is relatively concentrated in certain sectors. Climate change happens at the sector level, so as an asset owner you need to understand the sectors that you take risk in better. It’s important not just to look at the bond itself, but how it fits into the overall strategic asset allocation.
PI: Is new regulation being introduced giving investors more confi- dence that a bond is as green as the issuer claims? Gull: You have to rely on your credit analysts. We don’t buy any- thing because it is green and are not mandated to accept a low yield for that. We just think about the core fundamental of are we going to get our money back. Clearly, if they are doing the right things then that’s fine, but it is more about what the overall borrower is doing rather than how it’s using that stream of money. Freedman: Given the different flavours of bonds being launched, investors are listening to different stories. It is hard to measure or get consistency in the data, so we need standardisation. What the European Commission is doing is absolutely going in the right direction, but it should not be too restrictive, because there are only a certain number of eligible green projects out there and the market needs large liquid bond issuance. Pickering: I find prescription a hindrance rather than a help. Peo- ple end up getting definitionally focused, asking if they are com- plying with a definition or not, but that definition might have been designed five or 10 years ago.
I am more interested in having clear principles and allowing pro- fessionals to apply those principles where it makes sense rather than keep looking back to see if I am complying with this prescrip- tion or that prescription. It becomes legalistic and counterproductive. Gull: Some of the issues we face around ESG are that it is complex and nuanced. There is a huge degree of uncertainty about what is going to happen making it hard to measure some of these things.
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February 2020 portfolio institutional roundtable: ESG and fixed income
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