Institutions have started taking climate change much more seriously over the last two years as the dialogue around the issue changed in focus away from ethics towards risk management with high-profile commentators, including the Bank of England governor, Mark Carney, suggesting asset owners were in breach of their fiduciary duty if they failed to account for the risks associated with climate change. Peer pressure has also mounted as more institutional investors have signed up to initiatives such as the Portfolio Decarbonisation Coalition. Meanwhile, regulators are also increasing the pressure through agreements such as COP21 and are becoming increasingly aware of the powerful force asset owners can play in financing and policing the corporate sector.
Financial innovations, including green bonds and low-carbon indices, have also made the historically challenging task of green investment considerably easier. Some of the world’s heavy-weight institutions have already allocated significant assets to these innovations, including CalSTRS, the New York State Common Retirement Fund, Sweden’s AP2, France’s Fonds de Réserve pour les Retraites (FRR) and the United Nations Joint Staff Pension Fund.
Lombard Odier’s Bertrand Gacon, head of impact investing and SRI, says green bonds should be a “no brainer” for institutions. “Green bonds allow institutions to invest in green projects without compromising on their fiduciary duty to provide long-term returns and risk management processes,” he says.
NO COMPROMISE
Green bonds offer the same risk and reward profile as traditional bonds from the same issuer because the default risk associated with these bonds relates not to the specific environmental project being financed, but to the issuing entity. It is therefore the company, not the investor, that carries the risks associated with the specific project.
In terms of yield or spread, there is currently “no difference compared to nongreen bonds from the same issuer”, according to NN IP’s Bos. “In the long-run you could argue that companies who are issuing green bonds are serious about climate change and have lower risks of, for example, having stranded assets on their balance sheets.
“We think that the risk of this type of company running into difficulties is smaller and would argue they have a more attractive risk-return profile in the long-run,” Bos continues.
So do investors have to compromise on returns to fund environmental projects? “Quite the opposite,” says Frédéric Samama, Amundi Asset Management’s deputy global head of institutional & sovereign clients. “Low carbon indexes have outperformed the market over the last five years.”
The MSCI Europe Low Carbon Leaders index returned 8.75% in the period between November 2010 and May 2016 compared to 7.93% for the MSCI Europe. Between November 2014 and June 2016, the excess return of the MSCI Europe Low Carbon Leaders index was 120 basis points versus the MSCI Europe with an information ratio of 1.25.
Another area where the compromise of green investing has been overcome is that of liquidity. Traditionally, investors would have to choose between either investing in highly targeted projects through private finance, or by going down the less-targeted ESG route.
“Green bonds enable us to design high-impact strategies within a liquid asset class for the first time,” Lombard Odier’s Gacon says. “Liquidity levels are very similar to conventional bonds, but with slightly less volatility,” he continues.
