Environmental, Social, and Governance (ESG) Investing In Bonds: Is It Taking Off And Paying Off?

In addition to a once-in-a-lifetime global pandemic, 2021 has brought not only a groundswell of activism on the urgent challenge of climate change and the need for a more sustainable future, but additionally an awakening of racial and social justice movements globally. This varied concentrate on sustainability gained widespread public attention – and today it is increasingly capturing investors' attention.

Environmental, social, and governance (ESG) investing is easily gaining ground with Singaporean investors and is increasingly prevalent in bond funds.

Widespread integration of ESG factors in fixed income investing has become more mainstream, but possibilities to invest in it directly in Singapore have historically been relatively limited. That's beginning to change as investor demand drives the creation of more offerings.

As investment options start to proliferate, what should investors learn about how ESG investing works in bonds? And does it really pay to be more sustainable?

More Green, Social And Sustainable Bonds Are Being Issued

Sustainable bond investing is getting a boost right now from two different forces which are working together: supply and demand.

More supply is coming from the fact that the issuance (or creation) of green, social and sustainable bonds have proliferated this year, and the composition is broadening globally.

Historically, more European companies have tended to issue this kind of debt, but the recent trend has spread to the US and even emerging markets. In 2021, ESG related issuance in Europe and the US is comparable at EUR 47.5 billion and USD 41.3 billion, respectively. Going forward, there is even scope for brand new debt issuance in the US to eclipse Europe, with 2021 predicted to become the first year in which more green debts are sold in dollars than in euros.

A wide selection of companies have come to the market issuing this kind of debt recently, led by utilities, banks, REITs, and technology. This confirms that companies are acknowledging the growing curiosity about sustainable investing and the trend isn't confined to companies facing sustainability pressures. Some companies, particularly utilities, go further, stating that they are unlikely to ever issue another “non-green” bond since all of their financing will be linked to sustainable programs.

Companies (and countries) have cited a host of reasons for issuing ESG-related bonds. For example, a utility could be financing a transition away from coal-fired power generation, towards renewables. A bank can use the proceeds to help fund construction, rehabilitation, and/or preservation of affordable housing for low-income populations. A car company could issue an environmentally friendly bond to build, research and develop electric vehicles.

Somewhat similarly, when it comes to countries issuing debt, we've seen funds being raised to assist the transition to a lower carbon economy, to cover investments in science, technology and public education and also to finance public health related expenditures.

Appetite and Demand for ESG Strategies Has Increased

The other major driver for sustainable bond investing is demand. There has been an explosion of investor curiosity about ESG driving the creation of more dedicated investment solutions that deliver sustainable outcomes without having to sacrifice returns.

Reflecting this appetite, assets in ESG funds have grown to USD 565 billion globally after September, which is an all-time high and a 43% increase year-to-date. Coming off a relatively low base, a particular area of growth has been sustainable bond funds, which offer retail investors an ESG-friendly way to still achieve their income and diversification goals.

Sustainable Purchasing Bonds Is Not Just Limited To Green Bonds

However, it is important for Singaporeans to realize that sustainable investing in bonds isn't confined simply to debt that's explicitly labelled as 'green bonds.' It also includes issuers whose fundamental business practices exhibit sustainable characteristics-for instance, diligent control over water and waste resources, promotion of the health and safety of employees or diversity of board members.

Professional investors who are able to pick through these securities to obtain the most sustainable companies are able to construct portfolios from a number of types of debt. More disclosure from companies around ESG, like the material impact that climate change could have on their operations, helps investors make more informed decisions and conduct more sustainable research and credit analysis.

Investors Should Look Closely At The Manager And Issuer When Selecting Sustainable Bond Funds

Increasingly there are loads of investment options, whether you are looking for a low-cost ETF or an actively managed solution. So what should investors look for when going sustainable in bond fund selection?

Investors need to look for professional bond investors or fund managers who view themselves as lenders of the clients' money, aligning their fiduciary responsibility with an expectation that the issuers by which they invest should work in a sustainable manner and demonstrate high standards. Managers need to have the resources and research capabilities-both to complete their homework and analyse issuers' ESG practices in parallel using their credit profile, and to cover the whole fixed income market given that ESG considerations for countries are inherently not the same as those for companies. With industry standards and data evolving quickly in this space, it's also important to find a manager who is keeping pace with the changes.

Additionally, look for a fund that actually uses the assessment of ESG practices of each issuer in which they invest as a driver of performance, so you'll know it's truly sustainable. For instance, active investors have the ability to evaluate each bond on its own merit. They can look across the fundamentals, technicals and quantitative valuations to pick the best sustainable bond investments that fulfill their ESG characteristics and deliver solid returns.

The final point here is that you can't purely look in isolation at the fundamentals of those issuers to judge whether or not they're sustainable, additionally you need to make sure the price is right to maintain your returns on track.

Sustainable Bonds Have Outperformed In this Year's Market Volatility

At the end of the day, a key question for investors is whether sustainability pays off in terms of their financial returns. Results thus far in 2021 indicate that it does. Throughout the extreme market volatility we had earlier this year, sustainable funds notably outperformed the competition. Also, research shows that ESG strategies generate better risk-adjusted returns within the long run.

No matter how you decide to get access to more sustainable investment solutions, what seems clear would be that the trend toward further future sustainable issuance, whether spurred on by government regulations or by broader investor demand, is sure to continue. That should increase the opportunities available for Singaporean investors to add sustainable bond funds for their portfolios that can potentially perform well whilst also doing great for the world.

Marika Dysenchuk, Executive Director, is part of the Global Fixed Income, Currency & Commodities (GFICC) group. Based in London, Marika is an investment specialist covering unconstrained fixed income for prospective and existing clients. She is involved in managing client relationships and growing the company, product development, marketing, research and analysis efforts. Marika holds a B.A. in psychology and art and architectural history from Middlebury College.