Passing fad or new wave?

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As demand for sustainably invested products gathers pace, issuers of sustainability-linked bonds (SLBs) are gaining inroads to fixed income markets. Here, Insight Investment portfolio manager Lutz Engberding, assesses their appeal.

As investors sharpen their focus on environmental, social and governance (ESGs) factors and explore ways to invest sustainably, the market for products such as green bonds continues to grow apace.

According to the World Economic Forum, green, social and sustainable bond markets have seen rapid growth this year, with a very strong uptick registered in the first half of 2021. Climate news agency and data provider Bloomberg Green reports the value of green bonds alone issued in the first six months of 2021 exceeded that of the whole of 2020, at US$248.1bn.1

Against this backdrop, Insight Investment portfolio manager Lutz Engberding says issuers of sustainability-linked bonds (SLBs) are increasingly making their market presence felt.

These types of bonds carry coupons linked to achieving sustainability targets – unlike sustainable bonds, which are essentially use-of-proceeds bonds that can support both environmental and social projects.

SLBs differ from traditional green and social bonds in that their issuers, while tied to various sustainability performance pledges and key performance indicators (KPIs), have no restrictions on how their proceeds can be used.2

Issuer appeal

This means certain types of companies, such as oil and gas producers which might not typically appeal to sustainability-focused investors, can attract investors interested in efforts by these issuers to improve their performance against measurable sustainability performance targets.

Engberding has noted a marked increase in interest in these funds throughout 2021 and growing issuance.

One of the main market novelties this year has been the rise of sustainability linked bonds,” he says. “While sales of so-called use-of-proceeds green and social bond have continued apace, we have seen close to €60bn issuance of SLBs in 2021 in a market which was virtually non-existent last year.”

A shift by the European Central Bank (ECB) to accept sustainability-linked bonds as eligible collateral last year has also helped improve the technical picture for these bonds, raising both their credibility and attractiveness to investors. Previously a technicality with the coupon on these bonds had excluded them from ECB eligibility, adds Engberding.

He believes SLBs are more than a passing fad, though he says investors should give careful scrutiny to the individual terms, coupons and targets they offer.

There is no doubt many companies have got their frameworks in order and are ready to issue SLBs in the current market. Changes in the regulatory eligibility of some products have also opened the market for environment-related bonds and sectors which are not typically issuers of green bonds and we have seen a few examples in those areas,” he says.

We expect this sector will gain traction and relevance into next year as well, though investors should consider the KPIs and the coupon structure of each SLB carefully as they can differ from issuer to issuer.

Inflation threat

While SLBs and other sustainable investment friendly instruments continue to attract investors, Engberding is keeping a wary eye on wider macroeconomic developments. While unfazed by talk of potential interest rate hikes, he is concerned by the inflationary outlook.

We are concerned about inflation rates, which are well above central bank targets. When looking at the prices of certain financial assets we feel inflation risks are under-appreciated to some extent. Policymakers are starting to acknowledge we have more permanent inflation on our hands than was previously the case, though real policy rates remain deeply negative,” he says.

Our general view on interest rates is that the inflation phenomenon we see in much of the world is likely to last a bit longer than policymakers initially believed. We do not believe it is transitory or will ebb away very quickly. We have seen a lot of volatility in the level of interest rates across markets and the shape of the yield curve this year but will have to wait and see how 2022 unfolds.”

1 World Economic Forum. Why green bonds are beating all expectations in the post-pandemic recovery. 20 July 2021.
2 S&P Global. Sustainability linked bonds in ‘rapid growth’ as more firms tap ESG Market. 23 June 2021.

782705 Exp: 10 June 2022

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