Morningstar - Q2 2023 - 36

Spotlight: Bonds
Sustainable Bonds Present
New Opportunities
ESG practices can help investors
identify the best-managed issuers.
Leslie Norton
ESG
" Bond selection is primarily a negative art. It is
a process of exclusion and rejection, rather
than of search and acceptance, " Benjamin Graham,
the father of value investing, famously said.
And yet, for this negative art, the opportunities
could be greater than they've been for years.
At the same time, the advantages of investing in
sustainable bonds are growing swiftly.
All investing is about evaluating risk relative
to return. While equities are about maximizing
returns, bonds have focused on preserving
capital. As with all bond managers, of course,
a sustainable-bond fund's first responsibility
is to invest in reliable borrowers. Equity investors
have scrutinized environmental, social, and
corporate governance factors-financially material
elements that aren't part of traditional
financial metrics. Now, their benefits for bond
investing are increasingly compelling.
Strong ESG practices, such as diverse boards
and workplace safety, can help identify
the best-managed issuers. That's a big plus
for a bond investor.
" It's a no-brainer on the fixed-income side, " says
Peter Coffin, founder and president of Breckinridge
Capital Advisors, a Boston-based fixed-income
investment manager with over $41 billion in
assets. " It's using new data that is more and more
widely and accurately reported, that could
prove very material and relevant to an issuer or
36
Morningstar Q2 2023
company or municipality's long-term prospects.
We really view ESG as an enhancement to our
fundamental research, and we feel as fiduciaries,
as investors and managers, that we have an
obligation, a responsibility to use it. "
Steve Liberatore, who manages $20 billion
of assets, including TIAA-CREF Core Impact Bond
TSBIX, TIAA-CREF Green Bond TGROX, and
TIAA-CREF Short Duration Impact Bond TSDBX,
agrees. " ESG leadership is really valuable
as a risk-management tool, " he says. " If you're
doing it correctly, you're using ESG factors
to identify issuers who are the best operated and
managed. Issuers who perform well on ESG
scores are generally the ones taking into
account a wider variety of risk associated with
operations. So, when you see an issuer
doing that, it shows they're longer-term focused.
They have more stable free cash flow. "
For bond investors, the stability of cash flow
determines whether or not they get paid. But
sustainable-bond investing isn't a gimme.
Investors face plenty of challenges, including
potential greenwashing.
Sustainable-Bond Market Is Growing Quickly
As the discipline of integrating ESG into
bond research and portfolio management has
grown, so has the market for sustainable
bonds, making it easier for investors to find
them. Today, the global universe for sustainable
debt is approaching $5 trillion, up from
$3.4 trillion in 2021, according to the Institute
of International Finance. The IIF expects
total ESG debt issuance to hit $1.7 trillion in
2023 and $2 trillion in 2024.
" The next few years are expected to bring
rapid growth and development in sustainablebond
markets, as companies around the
world seek to finance innovative green projects
and capitalize on the tremendous business
opportunities associated with the transition to
a low-carbon future, " says Sonja Gibbs, the
IIF's head of sustainable finance.
Likewise, the size of the fund market has
ballooned. Globally, assets in global sustainable
fixed-income funds have grown elevenfold
in the past decade to $516 billion at the end of
2022, from just $45 billion in 2013, according
to Morningstar ( EXHIBIT 1 ). Indeed, even
though investors pulled a record amount of
money from mutual funds and exchange-traded
funds last year, sustainable-bond funds
had positive inflows.
Sustainable-bond funds are most popular
in Europe, which accounts for nearly 90% of all
assets, driven by institutional investors. European
asset managers pioneered ESG integration in
fixed-income management and launched socially
responsible fixed-income funds beginning
in the early 2000s. That's driven in part by local
institutions. Since the 1970s, for example,
Norway's sovereign wealth fund has incorporated
sustainability criteria in its investment objectives.
More recently, the world is following Europe's
lead. The 2015 Paris Agreement, the
release of the European Union's Action Plan
for Financing Sustainable Growth in 2018, and the
Sustainable Finance Disclosure Regulation
in March 2021 have accelerated the adoption of
ESG strategies by institutional investors
across the globe.
Impact Is Important
If bond investing is a negative art, sustainable
investing is a positive one. In particular,
impact bonds, a popular theme among sustainable
investors, are flourishing. Impact describes
the part of sustainable investing that emphasizes
the broader effects of investments on people
and planet. For fixed-income investors, this often
means considering a bond's use of proceeds,
focusing on bonds that finance projects to benefit
communities and the environment.
https://www.morningstar.com/funds/xnas/tsbix/quote https://www.morningstar.com/funds/xnas/tgrox/quote https://www.morningstar.com/funds/xnas/tsbix/quote https://www.morningstar.com/funds/xnas/tsdbx/quote
Morningstar - Q2 2023

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