Green Bonds: How Active Management Aims to Make the Most of a Dynamic Sector

Author: Johann Plé, Senior Portfolio Manager, AXA IM Core

The market for financing linked to environmentally friendly projects and companies has already reached $1trn by some measures and we expect will move swiftly past that landmark during 2021. This, alongside growing policy support in Europe, the US and China, has helped make the green bond sector a powerful draw for investors. Increasingly, they are aware that climate change is a threat to our economic well-being, and that green bonds can potentially be a crucial part of addressing that threat.

In our view, it is one of the most dynamic areas on the path towards a sustainable global economy, and a sector where in-depth active management can help deliver financial returns alongside genuine environmental impact. As with any dynamic asset class, the evolution can be dramatic. Green bonds have moved on from a focus on Sovereign-related issuance and a few utilities, towards a better-balanced mix that draws in far more diversified sources of credit.

Active management can enable us to adapt to the pace of market changes and allocate to the most defensive/expensive parts of the universe when needed, and its most attractive, higher yield parts when opportunities arise. Another potential advantage for active investors lies in access to primary issuance – which provides liquidity and avoids the additional transaction costs in the secondary market faced in a passive/exchange-traded fund (ETF) approach.

Delivering Impact

Perhaps the most common question when investors consider green bonds centres on how they can be sure what is green and what is not. The market may be growing every year, but regulation has not yet emerged that allows for consistent definitions of environmental goals and parameters, or which ensures consistent transparency around issuance. Again, an active approach is crucial to ensure the selection of credible green bonds across the universe in a way that is clear and straightforward for clients. We believe it is important for large players in this market to not only enjoy the potential financial returns, but to support truly meaningful environmental projects from companies whose strategies are aligned with the energy transition.

An active approach can enable investors to focus on issuers that provide the most transparency about the projects they finance and about their potential impacts, such as tonnes of CO2 avoided. This kind of information allows investors to understand the true nature of green bonds, to know precisely how their money is financing a change and by how much it is contributing. This is a fundamental aspect of green bond investing that a passive approach would simply miss.

Active, and Engaged

To truly be a part of the energy transition demands more than simply buying green bonds. We have a deep commitment to stewardship across all our assets and believe this helps to keep us close to the heart of the green bonds market. We think it makes sense to maintain a continued dialogue with existing and potential issuers about how they might start, continue or increase their commitment according to their specific economic activity.

Our analysts have met with close to 90% of the issuers we hold in our green bond strategy, and more broadly, our membership of the ICMA’s Green Bond Principles Executive Committee affords AXA IM and its clients a voice in the push for industry guidelines to improve transparency and disclosure. We also closely monitor the market, so that we might reward issuers with allocations when they improve their standards, or to review investments which fail to meet our standards.

Putting It to Work

Our green bonds strategy seeks to deliver impact alongside returns, but how can asset managers make sure issuers meet those standards when building a strategy?

Before assessing the credibility of a green bond issuance, our approach is to first filter the universe to reflect our group-level exclusions policy and to remove any possible controversial activity, sector, or issuers that could be associated with poor environmental, social or governance (ESG) practices. Our ESG scoring system helps identify poor ESG issuers.

But what really makes the difference is our proprietary green bond framework. This is the tool with which we seek to overcome the lack of common measures in the market, by setting clear and consistent standards which issuers – and clients – can understand. The framework is the engine for our active strategy.

It is designed to deliver an over-arching assessment of each bond under consideration and aims to ensure projects earmarked for funds by a company reflect a wider commitment to tackle climate change. We assess the issuer’s sustainable strategy, the demonstrable environmental benefits of the projects to be financed, the management of the bond proceeds and the issuer’s impact report. The framework also demands a high level of transparency.

This combined approach refines the investment universe to strip out about 25% of issuers. The goal is to minimise the risk of “green washing” while building a diversified strategy that avoids “extreme” positioning and ensures consistency over time.

Transparency is vital from our side too. We believe a green bond strategy must be able to measure and report its environmental benefit to investors. This is why we produce a monthly impact report that includes specific indicators – such as emissions avoided – as well as details of the environmental projects financed. We also map investments to the UN Sustainable Development Goals.

It is impossible, we think, to deliver this depth of management without an active approach. Since we first developed a green bonds strategy we have sought to be a pioneer and a benchmark for the sector, taking care to burnish its credibility and support its growth. Only with high standards, careful research and a commitment to good stewardship can we genuinely limit concentration risk, weed out controversies, prevent ‘green-washing’, improve access to the primary market and shape the nature of issuance. By doing all this, we believe an investment manager should be able to generate more attractive returns and limit downside, while delivering genuine impact in the fight to take on the challenge of climate change.

This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalised recommendation to buy or sell securities.

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