When investing with a sustainable tilt, bonds as an asset class needs to be thought of very differently to equities, property and infrastructure. Pendal’s Michael Blayney explains

• Bond investors have several options to get a sustainable tilt
• Sustainable, green and impact bonds have different attributes
• A multi-asset approach provides greatest flexibility

A MULTI-ASSET approach to building a sustainable portfolio provides many more options than a single asset class.

But it also means investors have to understand how to go green within each asset class — and the implications that decisions in one asset class impacts other asset classes.

In Australian equities, where the market is more concentrated, fundamental active management is the optimal approach.

In international equities, the main implication of a sustainable fund is lower energy exposure. To achieve that it might be necessary to invest in correlated assets in other asset classes.

Sustainable investing in property and infrastructure involves fewer exclusions than the broader equities category, but it can be harder to find dedicated sustainable products.

What about fixed income?

“When investing with a sustainable tilt, bonds as an asset class needs to be thought of very differently to equities, property and infrastructure,” says Michael Blayney, head of Pendal’s Head of Multi-Asset.

“It is less about increasing in value, and more about avoiding defaults and impairments.”

In other words, investing in bonds is about much more than returns, as the world learned during the Covid downturn.

Bond markets are not simple, partly because derivatives are often needed across products to achieve interest rate and credit exposure outcomes. That makes bonds far more complicated than buying stocks.

But understanding the complexity allows greater flexibility in creating a sustainable portfolio across asset classes.

Blayney explains that credit spreads — the difference between what a government bond and a corporate bond of the same maturity is yielding — are tighter on sustainable indices.

“That’s because by their nature, they tend to be underweight in the riskier industry sectors, particularly energy,” he says. “ESG [environmental, social and governance] characteristics tend to correlate with higher quality businesses.”

There are also green bonds, where proceeds are earmarked for projects that have a positive impact on the environment. Increasingly there are also impact bonds that target social outcomes.

Comparing the different types of bonds – aggregate, sustainable and green – shows that yield to maturity is lower for the latter two. This is partly due to the country composition, with green bond issuance dominated by Europe.

	Global Aggregate	Global Aggregate Sustainability	Global Green Bond
Rating	AA-	AA-	A+
Yield to maturity (%)	1.05	0.79	0.53
Weighted average spread (basis points)	34	30	58
Duration (years)	7.5	7.6	8.5

Source: Bloomberg. Bloomberg composite rating shown. Data as at 19 July 2021. Global Green Bond Select Index proxied with an index tracking ETF.

“There are tools — futures or interest rate swaps — that allow investors to get access to the desired yield curve without the exposure to the market where the physical capital is allocated,” Blayney says.

The weighted average spread of the securities in the Sustainability Index is lower than the standard index, partly because of the individual securities and partly because of sector differences. While the credit ratings are broadly the same, when one index is rated higher it is always the Sustainability index. All indexes are investment grade.

“In the case of impact bonds, many are issued by banks. So they can have high creditworthiness while allowing capital to be directed to meaningful projects,” Blayney says.

“There’s also a relatively newer, and quite innovative range of credit securities where the coupon paid by the borrower is linked to achievement of various non-financial objectives.”

“Ultimately investors have a range of ways to express ESG preferences or insights within the bonds component of portfolios. We believe a blend of green bonds — sovereign and non-sovereign, other impact bonds, and sustainable corporates — can represent a solid core to a portfolio,” Blayney says.

Is it worth thinking green across your portfolio?

Yes, says Blayney.

“A broad universe of securities allows investors to give effect to a variety of ESG tilts within their portfolios,” Blayney says. “Generally, we expect less tail risk and a quality bias in moving to a more sustainable portfolio.”

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About Michael Blayney and Pendal’s Multi-Asset capabilities

Michael Blayney leads Pendal’s multi-asset team.

Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

The team manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.

Browse Pendal’s multi asset funds here

Find out about Pendal Sustainable Australian Fixed Interest Fund here

Contact a Pendal key account manager here

The net-zero movement is driving a ‘circular economy’ which presents opportunities for investors to make money and make the world better, argues Regnan’s MOHSIN AHMAD

• Circular economy crucial to net zero
• Companies with a technology edge are favoured
• Reverse-vending machine maker TOMRA aims to convert trash to cash
• Find out about Regnan Global Equity Impact Solutions fund

BY NOW most people know they need to understand the impact of the “net zero” movement on their investments.

Countries including Australia are pressuring companies to help reduce emissions to zero by 2050 – in order to limit a global temperature rise to 1.5 degrees Celsius above pre-industrial levels.

Science shows that’s the level needed to avert the worst impacts of climate change.

But “impact investors” also believe many activities needed to achieve net zero are an investing opportunity.

“In terms of getting to net zero, energy efficiency and switching to renewables is only going to solve half the problem,” says Mohsin Ahmad, a fund manager with sustainable investing leader Regnan.

“To get the rest of the way, we need to look closely at how we make and use products, and that’s where the circular economy comes in.”

What is the circular economy?

The circular economy is all about moving away from a linear model that we have known since the dawn of the industrial revolution, whereby we extract, we produce and we discard.

“It’s about producing more efficiently, repurposing waste, using more renewable inputs and ultimately that leads to less greenhouse gas emissions” Ahmad says.

It is also an investable trend.

From a portfolio perspective, there are three different angles, says Ahmad:

1. “One is to invest in companies that facilitate a more efficient production of goods and services
2. “Then there are companies that are enabling recycled inputs, renewables and biodegradable type solutions.
3. “And then there are companies that leave the ecosystem in better shape.”

Ahmad says one of the lessons from recent years is that companies that can help reduce natural resource intensity will be winners in the short term.

“These are companies that help others to minimise their input requirements and deal with some of the inflationary pressures currently prevalent.

“They will also be winners longer term because of their contribution to lowering greenhouse gas emissions.

“If we are going to speed up the transition to net zero, these companies play an important role in addressing the systemic challenge of climate change we face,” he says.

Stock story: Dürr

An example of one such company is German engineering firm Dürr, argues Ahmad.

Dürr is held in Regnan Global Equity Impact Solutions fund.

“They provide solutions to automotive and other industrial customers to improve their resource efficiency of production,” Ahmad says.

“One of the main areas they are focused on is paint application in the automotive space which is very energy and water intensive.

“About 70 per cent of the total energy consumption at an automotive assembly facility takes place in the paint shop. What Dürr has done is to significantly reduce the environmental impact of paint shops.

“They’ve been able to achieve a 67 per cent reduction in energy input in paint shops, a 71 per cent reduction in water, a 73 per cent reduction in volatile organic compounds and a 36 per cent reduction in the amount of paint being used,” he says.  

Watch this video to find out more:

Where to start

Investing in circular economy companies starts with understanding the United Nations Sustainable Development Goals, and then finding a company that addresses at least one of the underlying targets in a meaningful way, says Ahmad.

“Then we look for additionality.

“Is the company doing something that’s differentiated? Have they got a technology edge? Are they doing something innovative?

“We also like companies that are in the relatively early stages of adoption of the new technology with large addressable markets.

“Companies where penetration rates are just starting to kick off and there’s a long path of growth ahead.”

Find out more about Regnan Global Equity Impact Solutions fund.

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About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.

Understanding the downstream impact of a business’s actions is key to sustainable investing. Regnan’s MOHSIN AHMAD explains why

• Watch out for second-order effects of sustainable solutions
• A system-wide view required
• Find out about Regnan Global Equity Impact Solutions fund

YOU may have heard sustainable investors refer to the second or third-order effects associated with a business.

Understanding a business’s downstream impacts — sometimes referred to as “externalities” — is a key concept in sustainable investing. (Pendal CEO Richard Brandweiner explains the idea here).

Sustainability proponents can often fail to account for these effects when promoting a new solution.

That means responsible investors need to take a wide, system-level view when considering challenges like climate change and food security, says Regnan’s Mohsin Ahmad (pictured below).

“It’s not just farm-to-fork,” says Ahmad, who co-manage’s Regnan Global Equity Impact Solutions fund.

“It’s what happens before the farm — with a farm’s suppliers — and what happens after the fork — how a consumer manages recycling and food waste.”

This week London-based Ahmad was in Sydney to address Regnan’s Director Roundtable on Sustainable Agriculture, a meeting of top executives and directors seeking to improve agricultural and food production practices.

Second-order impact

Ahmad uses the example of biodiesel — a renewable and biodegradeable fuel — to illustrate how second-order effects can play out.

“Biodiesel reduces greenhouse gas emissions by 72 per cent versus conventional diesel,” he says.

“On the face of it, that sounds great.

“But when you look at the system-wide effect of everyone moving to biodiesel, there’s a lot more that’s going on when you scratch the surface.”

Land needs to be diverted from food production to produce biodiesel. Often, this requires deforestation and reduces biodiversity.

Forests are often replaced with monoculture which reduces the soil’s ability to sequester carbon. There are also knock-on effects in terms of chemical usage which generates run-off that pollutes waterways.

The net, system-wide result is that climate change is exacerbated, biodiversity reduced and food security risks rise as a result of wide biodiesel adoption, says Ahmad.

Positive impact

Second-order effects are not always negative, however.

Regenerative farming is often criticised as a high-cost approach with lower yields than industrial farming methods.

“That may well be true near-term. But what it doesn’t take into consideration is the system-wide positive effects of regenerative farming practices,” says Ahmad.

“The fact that you’re not using chemicals or you’re using less chemicals means there’s less pollution going into the waterways and less fossil fuel for fuel usage because many of these chemicals are produced based on hydrocarbons.

“There are benefits from a climate mitigation perspective and a biodiversity perspective… but also from the perspective of the soil health as well.

“Those practices, the evidence shows, improve the organic content of the soil which means there’s greater potential for carbon sequestration.

“It also means that there’s more water retention, your crops are healthier and as a result yields over time over the long run will actually improve based on regenerative farming practices.

“So, you can have this positive feedback loop as well.”

Ahmad says this means investors need to take a wide approach and pick solutions that are genuinely going to have a positive effect on whole system.

Read more about sustainable agriculture investing in Regnan’s Catalysing Sustainable Agriculture and Food Production report.

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About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.

Regnan’s impact investing team looks for companies that are well-placed to solve the world’s biggest problems. This is the story of one of those companies, British battery developer Ilika.

• More efficient batteries will revolutionise transport
• Solid-state batteries are at the cutting edge of technology
• Ilika is one of the few listed players in the sector

A FEW big problems are holding back the mass adoption of electric vehicles — and they’re mainly related to battery technology.

Electric vehicle batteries are slow to charge compared to pumping petrol. And they don’t store enough energy for long drives.

British innovator Ilika is developing solid-state battery technology to address both these problems.

“Innovative technologies are providing a solution to better batteries,” said Regnan’s Mohsin Ahmad. “This is the next big leap.”

Battery technology goes back a long way.

In 150 BC in Mesopotamia, the Parthian culture used a device known as the Baghdad battery, made of copper and iron electrodes with vinegar or citric acid. While they were probably used mainly for religious ceremonies, they were also the first known batteries.

Ever since, society has worked to create more efficient batteries – a race that’s been supercharged in recent decades with the development of renewable energy and electric vehicles.

“Batteries are the Holy Grail,” says Mohsin Ahmad, a fund manager in Regnan’s Equity Impact Solutions team. “It’s why we’ve taken a position in Ilika.” (Find out more about Regnan Global Equity Impact Solutions Fund here.)

British-based Ilika is a pioneer in the development of solid-state battery technology.

Lithium ion batteries commonly found in mobile phones have a liquid electrolyte solution keeping the cathode and anode apart.

On the other hand solid state batteries use a solid electrolyte which plays the role of separator, enabling the delivery of much higher energy density.

The benefits range from sharply faster charging rates and longer life cycle and storage rates, to improved safety and easier recyclability, Ahmad says.

Commercial applications

The potential market for solid state batteries is huge — and Ilika has two main targets.

The first is micro batteries used in medical devices and Internet of Things nodes.

The market for medical devices is huge and growing, and the benefits of long life, tiny batteries are clear. Ilika hopes to be producing micro-batteries for commercial use from next year.

The Internet of Things nodes are the infrastructure that will eventually allow driverless cars and communication between objects. While still further away, the potential is huge.

The second target market is electric vehicles (EVs). As Europe and North America continue to mandate far greater use of EVs, solid state lithium cells have the potential to achieve extended range and faster charging – two of the biggest impediments to sales and usage.

“There’s not many pure-play listed players that are focused on solid state batteries. Ilika has a number of partnerships with OEMs [original equipment manufacturers] including Honda, Jaguar, Land Rover and McLaren,” Ahmad says.

“We don’t think the market is appreciating the potential of micro batteries. These tiny batteries can go into implantable medical devices, they can be used in manufacturing facilities, and they can operate at high temperatures.

“They can enable Industry 4.0. Ilika has relationships with customers already and they are expecting first production next year.”

Making good progress

Production of batteries for EVs is still five or six years away, Ahmad says, but they are making good progress and the potential is huge.

“The battery can be one of the biggest cost components of an electric vehicle, and particularly while EV charging infrastructure is still being built, it would solve the ‘range anxiety’ problem,” he says.

Ilika has a bet on EVs and that is a very big potential market. There are also opportunities in medical devices and the Internet of Things.  Other potential applications could include wind turbine blade testing and wireless automotive sensors.

“That makes it an attractive investment proposition, Ahmad says.

“This is the next big leap, and it’s only a matter of time before the technology provides a commercial solution to better batteries.”

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About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the Bloomberg Global Aggregate Index AUD hedged by 1% p.a. over rolling 3 year periods.

Sondal is an investment analyst with over 19 years’ experience covering the Retail, Telecom, Media and Transport sectors. He joined Westpac Investment Management in 1999 and has previously held roles with Commonwealth Bank and Bell Commodities. Sondal holds a Bachelor of Commerce (Finance) and a Bachelor of Science (Maths and Statistics).

Half of all Australian advisers are expected to offer sustainable investing products by next year as interest in green and social bonds grows. Pendal’s Murray Ackman explains why

• 50% of advisers will offer responsible products next year; two-thirds by mid-2020s
• Green, social and sustainability bonds issues growing rapidly
• Not all bonds are alike — investors should watch ‘bang for buck’

A LITTLE over a decade ago, a group of Swedish pension funds phoned the World Bank looking for a way to lend money to projects fighting climate change. The result was the first ever Green Bond.

Today, it’s a market that is growing rapidly.

The number of green, social and sustainability bonds issued in Australia in the first half of 2021 almost equalled the total for 2020.

The variety of issuers is growing too, with more than 30 different institutions issuing bonds across a wide range of sectors.

“This is a market that is becoming more sophisticated and we’re pleased to be able to participate in this fast-growing market,” says Murray Ackman, a credit ESG analyst at Pendal Group. (ESG stands for Environmental, Social and Governance).

“We believe the future of investing will continue to be directly funding impact to benefit our environment and the less fortunate.”

So what is a green bond? And how can they play a part in a well-constructed portfolio?

Fundamentally, the term green bond refers to a bond issued to raise finance for a climate-related solution such as clean energy or energy efficiency.

Similarly, a social bond raises finance for an initiative that aims to improve social outcomes in the community like affordable housing or support for indigenous people. You can read here about a social bond that helped put a roof over the head of Sam and his family.

Green bonds can form an important part of a responsible investing portfolio. Financial advisers are rapidly turning towards responsible investing, according to industry researcher Wealth Insights.

About 40 per cent of Australian advisers now offer responsible or sustainable investing products to their clients. This is expected to rise to 50 per cent by next year — and two-thirds by the middle of the decade.

Pendal participated in a few different types of bonds this year, including a bond issued by the Asian Development Bank which funds projects that improve gender equality and women’s empowerment, known as a gender bond.

The funds raised will be used in projects including training and financing women entrepreneurs in Sri Lanka and providing vocational training to women in Laos.

Other types of green bonds include the Climate Awareness Bond from the European Investment Bank, the lending arm of the European Union.

This bond funds renewable energy and energy efficiency projects across Europe, including an offshore wind farm near Portugal, a battery factory in Poland and an energy efficient shopping centre and railway station in Finland.

Closer to home, the NSW Treasury Corporation Green Bond funds green projects including low carbon transport and buildings, renewable energy and land conservation.

Elsewhere in Australia, the National Housing Finance and Investment Corporation provides cheaper and longer financing to community housing providers to increase the amount of affordable and social housing in Australia.

How can green, social and impact bonds play a part in a portfolio?

Ackman says the performance of green bonds shows they can take the place of traditional bond allocation in a portfolio – and that many investors are taking a broader look at the market.

“We’re finding more and more clients incorporating funds that invest in green, social and sustainable bonds as part of their normal bond allocation,” he says.

When choosing which bonds to invest in, Ackman cautions against simply investing in any bond that says it will bring about an impact.

“We have a rigorous process where all criteria must be met before we can invest. Our impact goals are to find investments that seek to achieve targeted environmental and social outcomes in addition to financial returns,” he says.

Sometimes, the other activities of an issuer can be a warning sign.

“We won’t even look at an impact bond if we’re not happy with the issuer. A tobacco company with a green bond to recycle packaging would not pass our screens or our sniff-test of a sustainable issuer.

“With use of proceeds bonds, we must be happy with the underlying projects.”

Ackman says he has seen a number of impact bonds that ostensibly would support people who impacted by COVID.

“However, after looking a bit closer, we determined these weren’t the types of bonds we wanted to invest in as there were really just repackaged vanilla bonds.”

The other important thing to consider is how much impact the bond will have, what Ackman calls the ‘bang-for-buck’.

“We have an impact database so we calculate and compare how much impact we are helping to achieve by each bond.”

Read the green, social and sustainability bond full report here