How to Build a Sustainable Bond Portfolio

///How to Build a Sustainable Bond Portfolio

How to Build a Sustainable Bond Portfolio

Wall Street’s do-good investment boom is finally taking notice of the credit markets. Sustainable investment assets grew 37 percent last year, according to Bloomberg data, but the majority of those funds focus on stocks. That’s leading to some awkward conversations on Wall Street, as wealthy investors and foundations increasingly want to align their entire portfolios with their social mission but are finding few opportunities to do so in fixed income.

“Most of the people who are interested in incorporating ESG are interested in doing so throughout their portfolio,” says Rui de Figueiredo, co-head and chief investment officer of the Solutions and Multi-Asset Group at Morgan Stanley Investment Management. Yet, with a dearth of available fixed-income products categorized as environmental, social, and governance, those investors haven’t looked at it much. “But that creates more demand on the part of asset managers to create those opportunities,” he says.

Of almost 1,900 ESG funds tracked by Bloomberg, 15 percent invest in fixed income, vs. 62 percent in equity. On an asset basis, that figure is even smaller, with fixed income representing about 3 percent of the $491 billion invested in such funds.

Bonds, though, have the potential to be a popular ESG asset class for impact investors, those who look to generate environmental and social outcomes along with financial return. Fixed income typically attracts investors with longer time horizons who might be more philosophically aligned with environmental and social issues, says Mike Amey, head of sterling portfolio management and ESG strategies at Pimco Investment Management Co.A World Bank report released in April details some initial evidence that ESG factors can help bond investors avoid default risk.

To fill the gap, asset managers are looking at the existing debt market with fresh eyes, tapping into potentially overlooked asset classes such as affordable housing and development bank debt to find investable opportunities for sustainability-hungry clients. They’re also trying to build infrastructure, such as benchmarks, that will support greater liquidity and investment levels in these products.

Here’s what’s going into sustainable bond portfolios.

DEVELOPMENT BANK DEBT. High-grade debt issued by the World Bank and other development banks offers some of the best-­performing do-good credit on the market, according to UBS Group AG, which found the debt delivered strong returns for its socially conscious private bank clients. “We weren’t asking clients to forgo any expected returns,” says Simon Smiles, chief investment officer for ultra-high-net-worth clients at UBS’s wealth-management division. Development bank debt turned out to have “a very attractive expected risk-return over a cycle for AAA-rated debt,” he says. That performance encouraged Solactive AG, a German provider of indexes, and UBS to create in April a development bank bond index family to make the debt more accessible for investors.

GREEN BONDS. The market for environmentally friendly bonds is expected to hit a record $170 billion in new issuance this year, but the bonds are in relatively short supply, according to Bloomberg NEF. Green bonds represent less than 0.5 percent of the global fixed-income market. Most deals are oversubscribed, and their environmental credentials appeal to long-term investors who buy and hold investments. If you can get your hands on a green bond, you’ll find the sector has been dominated this year by sovereign, local government, and financial issuers, which use the proceeds to fund smaller projects focused on renewable energy, green buildings, sustainable water management, and the like.

Social and sustainability bonds, which concentrate on themes such as responsible farming or housing finance, are also a budding area, with about 25 deals this year. But there are only about 110 bonds on the market, representing a total issuance of about $47 billion, according to data compiled by Bloomberg.

Read more at Bloomberg