If you want the broadest possible opportunity set, then it is important to look at impact-aligned bonds that are not labelled as such, says Tom Moulds.
Sustainability is a term applied to many products in the asset management landscape, but in fixed income, this label does not always reflect all the underlying activities of corporates.
It is no secret that sustainable investing in fixed income can often lack transparency, especially in emerging markets. However, that doesn’t mean there aren’t exciting investment opportunities. For this reason, it is important to look beyond green labels and determine which issuances are having the greatest impact while producing alpha.
Conducting bottom-up research is essential because the quality of ESG-labelled bonds can vary tremendously. Some frameworks are extremely robust, showing that issued bonds are dedicated to new environmental projects. Conversely, you can have green-labelled bonds which are merely financing five-year-old projects or are refinancing older securities with only a few green bonds.
When researching corporate issuers, we start by assessing the materiality of the organisations to see if they align with our sustainability themes and qualify under our framework.
Once we’ve established whether the activities of an organisation are compatible with our investment philosophy, we have the freedom to invest in issuances that are not clearly labelled as sustainable. This is important as ESG-labelled bonds will not always represent the best investment from a returns perspective.
For instance, an issuer which has qualified under our framework and is materially committed to sustainability could have a green bond and a non-green/vanilla bond. On the surface, the standard bond might not appear sustainable as it doesn’t have the green label, but its market impact is the same. As a result, if the vanilla bond trades cheaper than the green bond then it would represent the better investment opportunity.
Emerging market opportunity
While our approach to identifying sustainable opportunities remains constant across all jurisdictions, we have found that emerging markets provide a plethora of smaller, sustainable issuers to invest in.
Indeed, around 20% of the BlueBay Impact-Aligned Bond Fund is invested in emerging markets, reflecting our desire to invest in a broad, global investment universe. You can compare this to the Bloomberg Global Investment Grade Corporate Bond Index, where emerging markets only account for around 5%.
In recent years we have seen more bonds issued by corporates and sovereigns in emerging markets, providing exciting solutions in areas of the world where they can have the greatest impact.
For instance, we have invested in bonds issued by the International Finance Facility for Immunisation, which provides funding for vaccine programmes in emerging economies. On the surface, it is labelled as a sovereign-backed issuance, but the use of the funds is very much that of a sustainable issuance.
We’ve also recently invested in a bond issued by the International Bank for Reconstruction and Development. It’s a sovereign-backed entity where proceeds are directed to emerging markets’ social sustainability projects. However, part of the coupons are also used to protect rhino populations in South Africa – it is effectively a conservation as well as a development bank bond.
These examples illustrate that investments in fixed income are not always what they appear on the surface – in many cases, they can be more sustainable. As the number of sustainable issuances grow and the global agenda continues to progress, we mustn’t solely rely on labels to guide our decision-making and let opportunities slip through the net.
At times, the market for investment grade bonds may dry up, which could make it difficult to sell these bonds, or the fund may only be able to sell them at a discount.
There may be cases where an organisation with which we trade assets or derivatives (usually a financial institution such as a bank) may be unable to fulfil its obligations, which could cause losses to the fund.
BlueBay’s analysis of sustainability factors can rely on input from external providers. Such data may be inaccurate or incomplete or unavailable and BlueBay could assess the sustainability risks of securities held incorrectly.
BlueBay could suffer from a failure of its processes, systems and controls – or from such a failure at an organisation on which we rely in order to deliver our services – which could lead to losses for the fund.