A fair return that doesn’t cost the earth. Environmentally friendly income. A portfolio of bonds that offer a fair return given their credit risk, but also beat the broader market in the environmental, social and governance credentials of the issuers. I like that combination.
Floods, drought, tsunamis, the Munich Re study lists them all and carefully tots the natural disasters up. And concludes that the number of “damage events” between 1980 and 2015 has almost quadrupled. These statistics are by no means about surprising exceptions for the figures are steadily climbing, or so the re-insurers noted in March 2016. At first sight it the politicians who must to act, for example by introducing international treaties and agreements in order to brake the global warming underlying this process. That said, corporations must also act as their production processes contribute to the warming. And the more the companies rethink things, the better for their investors, too. A linkage that is becoming ever more important.
Bonds instead of bank loans
Companies are increasingly turning to the capital markets for financing. Meaning they float bonds that investors buy. The latter first assess the securities in light of key criteria: the interest offered and the risk of default, for example. After this analysis, they decide whether to buy or not.
In this context, another criterion is becoming ever more important. And it has to do with the climate. ESG criteria have added a new slant to these analyses. The E stands for “environment”, the S for “social” and the G for “governance”. Specialized rating agencies examine and evaluate companies’ strategies against an ESG yardstick, as in how much a company respects the environment or its workers needs. And adhering to the ESG benchmark has double benefits.
First, the environment benefits, as there the constant pressure on corporates to improve their behavior as regards ESG is paying off. For example, by reducing their greenhouse gas emissions. Second, investors benefit as studies show that the earnings prospects of sustainable bonds are as high as those for conventional vehicles, but the risk is slightly less. This attracts investors in a world of low lending rates and greater uncertainty. The “best-in-class” approach spells capital accruing to those companies who meet the ESG criteria better than do their rivals.
At first glance you wouldn’t see carmakers as big environmentalists. But even among them, some are better and some worse. General Motors, for example, emits about five times as much CO2 as BMW, directly in the form of greenhouse gases and indirectly via power consumption.
The advantage of the "best in class" approach is that companies are permanently under pressure from the competition to improve their sustainable behaviour. Because none of them wants to see their ranking drop or lose investors’ capital.
A portfolio with high ESG ratings over a portfolio with low ESG ratings produces higher returns. It can be argued that green and sustainable companies get better ratings relative to less sustainable positioned companies.
Interestingly enough, companies also get considered in sectors that certainly do not count as “green” – for example the oil industry. The approach focuses precisely on identifying those companies that are quantifiably better than their rivals, for example in terms of carbon dioxide emissions.
It is the rating agencies who decide. As with classical analysts who evaluate corporate bonds in terms of conventional core financial variables, the sustainability experts rate them in terms of an ESG benchmark. Companies that are more compelling get a better rating than those who hesitate on ESG. And conviction rests on strong foundations, as a meta-study of various studies shows. No less than 62.6 percent of analysts reported that ESG criteria impacted positively on value appreciation. And the confidence is even greater on the bond front – 63.9 percent believe ESG has a beneficial influence, whereas the figure is 52.2 percent for equities.
The lever – no financial tricks at all
The trend is likely to gain momentum and thus become a zeitgeist trend. As the “best-in-class” idea is forcing companies to compete for capital by behaving better. And this also compels investors to invest accordingly. A powerful lever as it were, that requires no financial tricks whatsoever. The volume of sustainably invested capital is already growing steadily and the more capital committed, the more power accumulates. Power to do something for the environment – and also to drive the performance of your own portfolio.
Sustainable bonds are a growing investment class driven by the political and social zeitgeist. Green yield, supporting investors and the environment alike.
Sustainable bonds offer many advantage when issued by well-established borrower and carry a high AAA or AA- rate, they are liquid, less volatile than other asset classes and therefore fit very well in a diversified portfolio that will include SRI compliant investment vehicles.