More and more investors are taking sustainability into account in their investment decisions. They invest in an ESG-compliant manner, i.e. according to the criteria of environmental and social compatibility as well as good corporate governance (Environment, Social, Governance, ESG). In practice, this is not easy. Equities and also increasingly bonds are the most important components of sustainable investing.

 

Responsible investing is becoming established

The international investor network UN Principles for Responsible Investment (UN PRI), supported by the United Nations (UN), has established six principles for responsible investment that need to be implemented. In this way, UN PRI aims to contribute to a more sustainable global financial system.

With its six goals – they are voluntary and non-binding – the PRI Association commits itself:

  • Integrate ESG issues into investment analysis and decision-making processes,
  • be “active owners” and integrate ESG issues into their own ownership policies and practices,
  • Ensure appropriate disclosure of ESG issues by the companies in which investments are to be made,
  • drive the acceptance and implementation of the Principles in the investment industry,
  • to work together to increase their own effectiveness in implementing the principles,
  • report on their own activities and progress in implementing the principles.

Responsible investment is no longer a niche strategy. As of the end of March 2020, UN PRI reported that it had more than 2,700 signatories worldwide, 29% more than a year earlier. Assets under management by UN PRI members and managed according to their sustainability criteria increased by 20% to more than USD 103 trillion during this period. USD, according to the PRI Annual Report 2020.

In Europe, sustainably managed assets almost already reach 50%, in the USA only about one third of the investment volume is managed according to ESG criteria. (Source: The ESG Observer Newsletter from The Market/NZZ, 15.6.2021).

 

Equities – the most important asset class

Equities are by far the most important ESG asset class. Overexploitation of nature, man-made climate change, unsustainable working and living conditions at production sites in emerging countries are leading investors to increasingly question not only the potential returns, but also their sustainability. Asset managers and managers of sustainability funds evaluate companies according to criteria such as “ecology” (climate protection, environmental policy), “social responsibility” (respect for human rights, social standards in the supply chain, safety and health) and “corporate governance” (bribery, corruption and transparency).

Reporting plays an important role. Not everything that looks green in glossy brochures is actually green. The sustainability report of companies allows conclusions to be drawn as to where possibly only a green label has been applied (greenwashing) and where serious sustainable work is being done. When looking for ecological and social shares and funds, one should also obtain one’s own information or information from third parties.

An ESG stock portfolio does not include companies that violate human rights and labour rights, that tolerate child labour and corruption. Certain fields of activity (such as armaments, the petroleum industry, gambling, speculation on food, pornography/prostitution, animal testing/torture) are also exclusion criteria. Professional investors seek advice from experts (investment committees) and prepare sustainability analyses in order to select the most sustainable companies (best-in-class approach).

 

Great need for information

The need for information for investors is great and not easy for them to obtain themselves. Fortunately, there is help. For example, the Swiss Association for Sustainable Business öbu, Zurich, in cooperation with engagebility, Zurich, evaluates the credibility of sustainability and annual reports of Swiss companies in the joint analysis platform “Focused Reporting“. Engagebility describes itself as a competence centre for innovative, future-oriented corporate solutions.

Every year, the Hamburg Institute for Management and Economic Research (IMWF) evaluates the official sustainability reports of several hundred companies and selects the best. Their shares are recommended for investment, even if hardly any candidate can fulfil all the positive criteria. However, the studies make it easier for investors to select stocks where social commitment, transparent corporate governance and commitment to nature and resources are actually and convincingly implemented. The most convenient way to bundle sustainable equity investments is via relevant funds, especially via low-cost ETFs.

 

Sustainable bonds offer diversity

The second major ESG asset class is bonds. While ESG equities have boomed in recent years, the issuing volume of sustainable bonds is now growing disproportionately. By definition, they encompass the entire universe:

  • green bonds (green bonds),
  • social bonds (social bonds) and
  • sustainable bonds included
  • sustainability linked bonds (SLB) and climate protection bonds.

The share of sustainable bonds in the global issuance volume of all bonds is growing dynamically and has doubled in 2020 compared to 2019: from around 5% to around 10%.

According to the rating agency Moody’s, sustainable bonds with a volume of USD 231 billion were newly issued in the first quarter of 2021. After only three months, this is already more than half of the issuance volume of the entire previous year of USD 490 billion. Moody’s estimates that issuance volume will reach USD 650 bn by the end of the year, an increase of 32%. The data is not clear and varies depending on the source (and delineation).

 

According to data provider Refinitiy, part of the London Stock Exchange (LSE), the issuance volume of sustainable bonds rose to a record $554.3 billion in 2020, more than doubling from the previous year. While green bonds also reached a new high of $222.6 billion, the overall spectrum has become much broader, ranging from social and sustainable bonds to sustainability-linked bonds (SLBs), which are firmly linked to a specific sustainability target, and climate protection bonds.

For sustainably oriented shares, investors often look at ESG ratings that agencies give to companies. In the bond sector, the assessment of sustainability is less focused on the issuer, but is oriented towards the specific design of the individual securities.

Based on four principles, the International Capital MarketAssociation (ICMA), Zurich, makes recommendations on how bonds should be structured and systematised:

  • Green Bonds Principles (GBP),
  • Social Bonds Principles (SBP),
  • Sustainability Bond Guidlines (SBG) and more recently
  • Sustainability Linked Bond Principles (SLBP).

The SLBP were not published until June 2020. Therefore, by September 2020, only four companies had issued SLBP-compliant securities: Enel, Suzano, Novartis and Chanel.

The ICMA’s guidelines shape what is now a USD 1.6 trillion market for sustainable bonds. USD market for sustainable bonds. According to ICMA, they were used as a basis for 97% of the new sustainability bonds issued in 2020. To be classified as a green, social or sustainable bond according to the ICMA standards, certain criteria apply to four aspects (each with verification by independent third parties):

  • Use of proceeds,
  • Project evaluation and selection,
  • Revenue management and
  • Reporting

The market for sustainable bonds is growing dynamically. There are a number of reasons for this – first and foremost a series of new regulations and the goal of climate neutrality proclaimed by many large corporations and national and supranational organisations, explains Richard Butters, ESG analyst at Aviva Investors. The EU, for example, has launched its “Financing Sustainable Growth” action plan to promote the transition to a more sustainable world after the Corona crisis.

In addition, companies would be very interested in taking advantage of the increased demand as additional sources of financing for their broader strategic goals. The field of interested parties is broadening. For years, the finance, real estate, utilities and renewable energy sectors dominated, but by 2020, consumer and luxury goods companies and mobile phone providers had joined the ranks, Butters said.

As an alternative to the ICMA system, the alignment of bonds and loans with “green” purposes or the goals of the Paris Climate Agreement can also be certified with the “Climate Bonds Standard” of the Climate Bonds Initiative, CBI.

 

SLBs are on the rise

The wide range of standards sometimes causes confusion. In the past, green bonds were almost exclusively reserved for issuers that were already considered sustainable. Companies with a poorer sustainability profile were denied this source of financing – even if they wanted to use the issue proceeds to convert to a more environmentally friendly business model.

With the increased momentum towards a more globally sustainable world, new types of bonds were in demand that would be more in line with the transformation efforts of the economy: Sustainability-Linked Bonds (SLB) and Climate Change Bonds.

SLBs differ from green, social and conventional sustainable bonds in that their issue proceeds do not have to be used for specific individual projects, but benefit the general financing needs of a company. With SLB, companies whose business models are not necessarily green are thus also given the opportunity to place sustainable bonds. For it is precisely when, for example, outdated production processes that are harmful to the environment can be improved to make them sustainable that the degree of effectiveness, the benefit for the environment and society, is high.

 

The effect counts

That companies can set performance metrics for their entire business and then issue bonds tied to them is what Tom Chinery, investment grade credit portfolio manager at Aviva Investors, thinks is a “brilliant” option. “An emissions-intensive company with ambitious savings targets makes a much bigger difference to the environment than a low-emissions company that commits to reducing its CO2 emissions by 0.01 grams a year,” Chinery argues. That is why he likes Enel’s recent large SLB placement totalling EUR 3.25 billion: The Italian utility wants to drastically reduce its CO2 emissions and has “linked” this plan to the coupons of the new SLB. If it does not achieve its CO2 reduction target during the term of the SLB, it must pay a quarter of a percentage point higher interest per annum.

How the impact of SLB can best be captured in standards and whether there is really a need for specific carbon bonds in view of the large number of bond categories is still a matter of controversy. However, it is crucial for investors to be able to understand what is happening in the issuing company and whether it can really achieve more sustainability via the placement proceeds.

 

Conclusion: Yields with a clear conscience

More and more investors are showing interest in ESG investments, and supply and demand are growing. Besides all the ethics and environmental responsibility, there is also the question of yield. The yield of green bonds tends to be slightly higher than that of conventional bonds. At least that is what the placements of Volkswagen and Citigroup suggest. Their sustainable yields are slightly higher than their conventional counterparts. However, this trend is not yet statistically verifiable. What is far more certain is that the market for sustainable bonds is developing extremely dynamically worldwide.

Even with ESG shares, ethics alone are not enough. The returns also have to be right. Sustainable shares that do not pay dividends are not interesting for investors. In order to meet the return requirements, only shares of companies should be selected for the ESG portfolio that are able to offer products and services under ESG conditions that can hold their own against the (non-sustainable) competition.


Manred Kröller
Financial journalist

 

 

This post has been translated automatically

 

 

Subscribe to our newsletter to never miss any new posts.