Investing in a just transition

In this way it could be said that fixed income bond fund managers are similar to passive investors, choosing the securities in which they want to invest that meet the criteria for sustainability, but theoretically unable to wield any influence over how and whether those policies are implemented. 

But Thede Rust, head of emerging markets debt at Nordea, says the key is that almost all bond issuers roll over the debt, that is, they pay the interest on the bonds, but then when it comes time to repay the principal, a new bond is issued to do this, rolling the debt over. 

Rust says this enables fixed income investors to exert influence on how a company is run, as the companies are likely to issue new bonds in future, so will need to show they have deployed the capital they previously raised in line with the expectations of the bond buyer. 

Engagement to drive change

Andrew Lake, head of fixed income at Mirabaud, acknowledges that bond fund managers have been slow at exerting this power, and are “playing catch-up” compared with equity counterparts, but says: “I have been surprised more recently at how much these firms want to talk to us, especially in the fossil fuel areas. I have had around 20 one-to-one meetings with companies in those sectors, and in the transport sector over the past year.

"Those companies know they need to change, and they are changing, even some of the quite small companies in the sector now have a dedicated person looking at sustainability issues, and as bond fund managers we work with them as we know they need to raise capital now and in the future.

"Our role is firstly to make sure that what they say is credible, for example, many firms issuing bonds will say their target is to be net zero by 2030, but of course we need to monitor that they are moving towards that goal now. There is no point in them starting that process in 2029, because simply that wouldn’t be enough time, so we work with them now.”

 Those companies know they need to change, and they are changing.Andrew Lake

In terms of what a fixed income bond portfolio looks like, he says: “We would have bonds of various different maturities, but you wouldn’t have very short-dated bonds in a sustainable portfolio, as there wouldn’t be enough time until the bond matures to make an impact.”

While investing in companies in order to drive change is something that Lewis Aubrey Johnson, head of fixed income products at Invesco, says is laudable, he cautions that many clients “wouldn’t feel comfortable” being invested in companies that are too early in the process of changing, and this can restrict the options available to investors. 

Genevra Banszky von Ambroz, sustainable portfolio manager at Tilney, says that if a short-dated bond passes an ESG screen, an investor has the advantage that the yield is likely to be the same as on a short-dated bond that would not pass such a sustainability screen, meaning that an investor does not need to sacrifice yield but can also attain investments that correspond to their sustainability criteria. 

Short-dated bonds also tend to offer protection against inflation and so are also potentially a diversifier in portfolios of all kinds. 

This may be particularly important in sustainable investment portfolios as they may be overly exposed to growth equities, which are vulnerable to higher inflation (see article four in this guide).

Rust says that under the sustainable finance disclosures regulation, an investor is required to monitor the governance and ensure that the company to which one is assigning capital is run by people who are “good actors”, that is, who are intent on delivering on the promises they make. 

Liquidity

Padhraic Garvey, an economist at ING, says there is a reputation among many market participants that fixed income ESG investors “buy and hold” and this can mean liquidity is an issue. But he says that as the sector has evolved in recent years, with more issuance happening, liquidity is no longer a problem.

The fact that bond investors in the ESG space may hold their bonds right to maturity helps to influence the behaviours of the companies in which they are invested, but – according to the ING analysis – without sacrificing liquidity. 

Obviously liquidity could suffer if the intention is to hold bonds to maturity, as when clients intend to make withdrawals the cash for this has to come from somewhere, either from inflows or from selling bonds or from holding onto cash.

 Many firms issuing bonds will say their target is to be net zero by 2030, but of course we need to monitor that they are moving towards that goal now.Andrew Lake

But also, if most bond buyers hold on, then it can be hard, in the context of a multi-asset portfolio, for an adviser to buy more of the same bonds for new clients as money comes in, as not enough would be for sale.

This would lead to the problem of bigger advice businesses or wealth managers being unable to access the green bonds they want. 

Garvey says his analysis also shows that because ESG-related bonds tend to be held for longer periods, the volatility in the pricing tends to be much lower than among conventional bonds, and that may help with diversification when used in the context of a winder multi-asset portfolio.   

david.thorpe@ft.com