Celebrating London Climate Action Week, this article features as part of IFA Magazine’s editorial campaign throughout this week, which aims to highlight key issues, news and views in the field of climate action.
The evolving fixed income market is spurring the transition to a more sustainable economy as well as enabling investors to build more diversified portfolios, say Samuel Mary and Lorenzo Brunelli.
The global sustainable bond market has materially grown and evolved over the past few years. PIMCO recognises the impact that climate change will have on the global economy and offers investors – through their bond allocations – the means to manage climate-related risks and take advantage of the opportunities associated with the transition to a net zero emissions economy.
A particularly important trend is the growth of ESG-labelled bond issuance, which is now spreading across industries and geographies rather than staying concentrated in a few key sectors.
“This really helps, on one hand, with the transition to a more sustainable economy,” says Lorenzo Brunelli, ESG Product Strategist at PIMCO. “On the other hand, it also helps asset managers like PIMCO to build up more diversified and robust portfolios.”
Green, social, sustainability and sustainability-linked bonds are all a part of the ESG-labelled bond universe, but with key differences.
Green, social and sustainability bonds are user-proceeds bonds, meaning the proceeds are used to develop specific projects such as renewable energy, green buildings and greener transportation. In the case of social bonds, the proceeds are devoted to the likes of basic infrastructure, affordable housing or security, health and safety procedures.
“The main benefit of the use-of-proceeds format from the investor’s perspective is the increased disclosure on the part of the issuer,” says ESG research analyst Samuel Mary. “For the issuer, they’re getting the capital that can help advance their sustainability strategy,” he says.
A NEW TREND ON THE HORIZON
Sustainability-linked bonds are a more recent trend that is rapidly garnering interest. “The issuance we have seen in 2021 was approximately 10 times larger than the numbers that we had witnessed in the previous year,” says Brunelli, indicating that this points to a category that is likely to develop further in
the years ahead.
These new instruments are not specifically dedicated to facilitating environmental and special projects, rather they are paid based on the issuer’s achievement of certain sustainability goals. Sustainability-linked bonds essentially reinforce the commitment of the issuers to sustainability in their business operations by directly tying them to their financing conditions.
“When they are well structured, it’s a very strong signal from issuers that they are committed to ESG and sustainability,” says Mary.
PIMCO believes it is critical that a wellrounded sustainability strategy shouldn’t be limited only to ESGlabelled debt, even in the context of an ESG-optimised thematic strategy like the PIMCO GIS Climate Bond Fund.
“That would be sub-optimal because you would be missing a number of interesting opportunities in bond markets, especially from those issuers that are not in a position to issue dedicated instruments or use-of proceeds bonds with a certification,” says Brunelli.
These segments could be unlabelled green bonds or they could be climate leader bonds, both of which are critical categories for PIMCO’s Climate Bond Strategy – a multi-sector thematic bond portfolio that invests beyond the green bond market.
Unlabelled green bonds are issued by companies that are structurally low carbon, for example a solar panel company or an electric passenger railway company.
“These are pure play or almost pure-play type of companies, and while they may not issue green-labelled, certified bonds, their businesses are nevertheless important to support the transition to a low carbon economy,” says Brunelli.
As for climate leaders, PIMCO defines them as issuers deemed to be at the forefront of net zero transition in sectors that are not structurally green.
“These are issuers that are demonstrating a strong commitment to mitigate their carbon emissions at company level across the full value chain, encompassing the reduction of their environmental impact overall,” Brunelli says.
A thorough assessment of any of these types of bonds is crucial. Having a label doesn’t always translate to high quality.
“A lot of analysis has to be put in place, and that’s the work of PIMCO’s ESG dedicated analyst team, to have a deep understanding of the ESG characteristics of each and every business and bond issuance,” he says.
STANDARDS HELPING TO IDENTIFY CLIMATE LEADERS
Mary says an important trend that has been gathering pace is the development of standards to identify climate leaders and those more committed to net zero.
“I’d highlight the Science-Based Targets initiative, which has essentially developed a framework and methodology to help issuers submit decarbonisation targets that are ambitious enough to be qualified as aligned with the goal of the Paris Agreement, including the most ambitious interpretation of the Paris Agreement, which is net zero,” says Mary.