Fixed income
Bond investing to support positive environmental and social outcomes
5 min read 10 Sep 24
Progress on the UN’s 17 Sustainable Development goals is lagging. With the target date of 2030 looming, less than a fifth of the goals are on track. With vital work still to be done, fund managers have an opportunity to address these critical gaps and accelerate progress. Mario Eisenegger, ESG bond manager outlines the role that bond investors can play to generate positive outcomes for both people and planet.
The world is in a state of transition, and humanity is faced with major environmental and social challenges, many of which are deeply interconnected. How we address issues such as climate change and social inequality now will define the future.
“Bond investors can be part of the solution by directing funding towards companies and projects that provide sustainable solutions.”
Going by one key roadmap to a better future – the UN’s 17 Sustainable Development Goals (SDGs) – urgent action is needed if we are to speed up progress on areas such as the climate, affordable and clean energy, and sustainable living. But only 17% of the goals have been deemed achieved or on track, according to the latest UN SDG Progress report. The world has a lot of catching up to do if the UN’s 2030 Agenda1 is to be realised.
Progress on areas such as climate action has seemingly stagnated, barely budging since last year – ‘when temperature records were shattered as the climate crisis accelerated in real time’. Nearly half of the targets laid down in the roadmap are making minimal or moderate headway, while progress on over one third of the goals has stalled or even regressed2.
Funding sustainable solutions
But there is hope – and investors have a major role to play. It is possible to align active fixed income portfolios with personal values and global sustainability goals, thereby ensuring that investors can contribute to a more sustainable and equitable future, according to Eisenegger. “Bond investors can be part of the solution by directing funding towards companies and projects that provide sustainable solutions,” he says.
Interesting investment opportunities in sustainable solutions are omnipresent and reach beyond the staple financing of renewable energy infrastructure, such as windfarms and solar panels. “Think sustainable aviation fuel, carbon capture and storage technologies, EV charging stations, location-based software to improve resource efficiency in agriculture, water treatment solutions, high precision surgery systems, affordable solutions which address high unmet medical needs, social housing or equitable quality education,” Eisenegger explains.
“All fund managers like myself require is a mandate to fund such sustainable solutions so that we can be laser-focused on generating positive outcomes for the planet and people when investing our client’s money”.
From farm to finance
Originally from Switzerland, the bond manager’s upbringing played a formative part in the foundation of his principles.
London’s frenetic and noisy financial district is as far as you can get from the gentle rolling farmlands on the fringes of Basel, where Eisenegger grew up and where he developed core values which play a huge role in his professional life today.
“Much of my spare time was spent helping out on the family farm. Every summer harvest would be a big community event where I learned important personal values of conservation, sustainability and generally being at ease with the surrounding environment,” he reflects.
Fast forward to 2024 and those core values are fundamental to Eisenegger’s work ethic. While he is a fund manager at one of Europe’s leading bond houses, being totally ESG-focused gives him clarity of investment purpose. He is enthusiastic about his job and the potential difference that selective allocation can make in the world.
“It’s been a dream of mine to help people grow their savings as a fund manager, while also investing for positive outcomes from an environmental or societal perspective – and this can now be a reality,” he explains. But how do we do it?
Allocating for positive change
In practical terms, the ESG bonds team first map their proposed allocation to six distinctive solution areas, depending on which positive outcomes are targeted. These are aligned with many of the UN’s SDGs, such as Better Health, Social Inclusion, and Climate Action3.
Following this, we believe there are two routes to portfolio inclusion when targeting a positive outcome. Firstly, having meaningful exposure to corporate ESG bonds, where the investment proceeds are directed towards a specific project targeting either environmental (green bonds) or social outcomes (social bonds), or a combination of both (sustainability bonds). At any given time, this would probably account for around 80% of the portfolio of an ESG bond strategy run by the team.
Encouraged by the interests of local pension funds, the first corporate green bond was issued in 2013 by a Swedish property company, Vasakronan4. The proceeds were used to help lower energy usage across the company’s properties and did so by about 50% of the sector average (while reducing carbon emissions by about 97%)5.
The Greenium: Paying-up for green bonds?
How much extra do investors need to pay for owning the green bonds of a company, compared to the same company’s conventional bonds? Well, the price premium for such instruments has been called the ‘greenium’. It derives from the extra cost of establishing a ‘green bond framework’, as well as ongoing allocation and impact reporting6.
“But based on our research, the so-called greenium levy is far less static than some believe”, explains Eisenegger. Some of this can be attributed to green bond investors forming a stickier investor base which can lead to price dislocations in periods of volatility.
Another factor is that fixed income markets struggle to price ESG bond instruments efficiently. Correct pricing of those securities is complicated by different green bond framework standards. Research from M&G Investments has also found that the greenium is partially driven by a scarcity premium rather than the impact achieved by the green instrument. In other words, an issuer with only one green bond outstanding is more likely to see its green bond trade at a greenium versus a company with a fully established green bond curve, even if the environmental impact achieved by the latter company is deemed larger. This gives active bond investors plenty of potential opportunities to pick up credible green bond securities, often relatively cheaply at zero or only very little extra cost.
A growing market of possibilities
A decade on and corporate green bond issuance dominates the ESG bond market, according to data compiled by Barclays7. Bond issuers that are present in public debt markets tend to have sizeable capital structures in place which allow them to invest heavily in sustainable solutions. Issuers can range from the likes of Apple, Credit Agricole, and SNCF, the French rail company.
Overall, global ESG bond supply from corporate issuers totalled $204 billion in the first half of 2024, mostly coming from utilities, banking, real estate and a few automobile companies. Today, ESG bond issuance accounts for 22% of total corporate supply in the European Investment Grade (IG) market, according to Barclays8. Regionally, while most of these bonds are issued by US, European and UK companies, recently there has been a significant rise in the number of Asian issuers, with volumes doubling for green bond issuance in the first six months of the year.
Although smaller by market share, social bonds and sustainability bonds have shown impressive growth rates recently, especially the latter with annual issuance increases of 40%9. A good example of a social bond in focus for the ESG bonds team is one issued by KBC Group, a Belgian bank-insurer. KBC has allocated the proceeds to the financing of hospitals in the Flanders region10.
“Balancing investment rationale with investment purpose, KBC’s social bond does both,” observes Eisenegger. “There is the solution element, the fact that proceeds can contribute to better health outcomes such as more hospital beds, and also the potential to benefit from relative value trades – or RVTs.”
RVTs occur when an active bond investor, such as M&G Investments, tries to identify value opportunities across sectors, issuers and different types of bonds issued by the same institution. In this case, the fund management team noted that KBC’s social bonds offered a superior financial compensation for the underlying risk over the Belgian company’s conventional bonds with comparable security characteristics.
The second route – one which Eisenegger and the ESG bonds team argue can be an important diversifier within building a positive outcome portfolio – is investing in sustainable solutions providers. A dedicated allocation of around 20% in an ESG bond strategy would comprise businesses seeking to make an impact in the world, playing an important role in supporting the UN’s SDGs.
These companies actively address problems linked to environmental and social challenges and are identified based on the value they provide through their core product or service offerings. Good examples of such investments, in our view, include Motability, a not-for-profit rental provider of specialist transportation for the disabled community, and Clarion, a social housing association.
“Exposure to such companies allows for better portfolio diversification and reduces the intercorrelation of holdings as it expands the investment universe to regions and sectors that don’t frequently issue ESG bonds. It also provides a greater number of RVT opportunities to try and take advantage of,” says Eisenegger.
As the ESG bond market continues to expand, more and more companies addressing the defining challenges of our times may emerge, and capital will play a crucial role in their evolution. For bond investors, this presents a chance to deliver for clients through both yield generation and the prospect of financing a brighter future.
Interconnected challenges and goals
Given that the goals of addressing sustainability challenges are deeply interconnected, we believe there is a strong case for an active ESG bond investor to be as diversified, informed and well-researched as possible, with the aim of making a positive difference in the long run. “We’re proactive in our selection,” comments Eisenegger.
He believes it’s easier to avoid certain companies and certain sectors. Having a reason not to invest in their bonds is the easy part. “The challenge is to identify those investments in bonds that will hopefully mean we progress to a better place,” he says.
“To achieve that I can count on large teams of analysts who are able to assess not only the fundamental outlook for issuers on an ongoing basis, but also the sustainability credentials. Investing with purpose while delivering attractive financial performance for our clients is very much a team effort and something that is deeply engrained in our investment DNA.”
