What to look for when investing in green, social, and sustainability bonds

To navigate this landscape, investors should look out for certain key criteria when investing in green, social and sustainability bonds (GSS).

The value of green bond expertise

Fundamental to any investment decision is an understanding of the asset class itself.

When investing in GSS bonds, it is vital to ensure the bond issuer or the fund manager has a deep knowledge of bond markets, structures and dynamics.

They should have a track record of managing bonds and understanding the nuances of yield, duration, credit quality and other bond-specific factors.

Green bonds also involve added layers of analysis and certification, so bond expertise is non-negotiable.

Geographical footprint: combining a European best-in-class perspective with a deep understanding of Asian markets

The US fixed income market is the largest in the world. Therefore, it goes without saying that a deep understanding of US markets is crucial.

That said, Europe has been a true pioneer in the sustainable investment space, and many European standards – such as the EU Taxonomy – are considered best-in-class globally. 

This makes the European approach an important benchmark for global investors.

As the demand for sustainable investments grows, so does the risk of greenwashing.

But it is increasingly essential to understand the nuances of Asian investment markets also.

Asia, with its diverse economies, regulatory environments, and cultural contexts presents both challenges and opportunities for sustainable investors.

Therefore, a deep understanding of both European standards and Asian market dynamics helps ensure investors can identify the best green bond opportunities globally and understand the associated risks.

The process: blending fundamental and quantitative analysis

For a comprehensive assessment, investors should look for an approach that blends both qualitative (fundamental) and quantitative analysis.

While fundamental analysis dives deep into a company's or project's management, competitive positioning and financial health, quantitative analysis applies mathematical and statistical methods to evaluate investments.

The harmony between fundamental and quantitative analysis is characterised here, which is ultimately crucial in successfully identifying and capitalising on market opportunities.

Balancing these two lenses of analysis means teams can provide a more comprehensive and sophisticated approach to investing in green bonds, always aiming to ensure that their clients' portfolios are both sustainable and profitable.

AI can provide an additional layer of scrutiny, helping to validate claims and ensure that investors are backing truly sustainable projects.

Overall, such an investment process is designed to integrate a top-down and bottom-up approach, leveraging both quantitative analysis and team input to construct a well-diversified and sustainable green bond portfolio.

The combination of these factors is at the portfolio optimisation stage, where a team should ensure the portfolio is well aligned with firm objectives and benefits from good diversification across a range of factors including issuer type, geography, and rating.

Alignment with UN SDGs

The 17 UN sustainable development goals provide a global framework for sustainability, from reducing poverty to building sustainable cities.

A comprehensive GSS bond strategy should seek to align itself with one or more of these goals, offering a clear pathway for impact.

Investors should prioritise GSS bonds or GSS bond fund managers that not only assert their SDG alignment but also provide transparent reporting on how underlying investments contribute to these global goals.

The tools: leveraging AI to gather and analyse data

Artificial intelligence has become a game-changer in terms of efficiently gathering and analysing available data.

Advanced algorithms can sift through vast reams of data to identify patterns, risks, and opportunities that would elude human analysts.

For GSS bonds, AI can be particularly valuable in providing a deeper and broader analysis of environmental impact data, social metrics and more.

Moreover, as the demand for sustainable investments grows, alongside the demand for meaningful data, so does the risk of greenwashing, where issuers exaggerate or make misleading or false claims on sustainable metrics and practices.

It is important to be close to management teams to better understand efforts to improve sustainable ratings.

In our experience, AI can provide an additional layer of scrutiny, helping to validate claims and ensure that investors are backing truly sustainable projects.

The due diligence: engagement and active stewardship

Active engagement means not just passively investing but working collaboratively with companies or projects to improve their sustainability performance, thereby creating a more significant impact.

In recognition of this, investors and respective management teams should maintain a clear channel of open communication and engagement, either through one-on-one meetings where they can engage directly with management and investor relationship teams or through group meetings.

It is important to be close to management teams to better understand efforts to improve sustainable ratings.

Engagement can also be helpful to fill gaps in our dashboard database by actively asking companies for enhanced information disclosure.

Andre Severino is the global head of fixed income at Nikko Asset Management