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Take care when investing in sustainability-linked bonds

Sustainability-linked bonds are growing fast, but investors should take care they are getting what’s on the label. Pendal’s MURRAY ACKMAN explains

MORE and more companies are selling sustainability-linked bonds — but investors should take care issuers are genuinely making changes and not simply greenwashing, says Pendal’s Murray Ackman.

Sustainability-linked bonds are debt securities that pay a coupon linked to the achievement of environmental or social outcomes.

Importantly, these “SLBs” are not linked to a specific project. They instead allow an issuer to set an overarching goal such as reducing emissions or improving diversity at a corporate level.

If an issuer fails to hit its goal, usually it pays a penalty in the form of a higher coupon.

“In theory, they are great — but we’re starting to see some things we are not happy about with these structures,” says Ackman, a credit ESG analyst at Pendal.

“We want to make sure that sustainability-linked bonds don’t turn into greenwashing because that will muddy the whole market,”

Pendal Sustainable Australian Fixed Interest Fund

An Aussie bond fund that aims to outperform its benchmark while targeting environmental and social outcomes via a portion of its holdings.

Fast-growing market

Sustainability-linked bond issuance reached US$103 billion last year — a one-year increase of 803 per cent, according to World Bank research.

That makes SLBs the fastest-growing sustainable debt instrument — with considerable potential to grow further on the back of strong investor, appetite and supportive government policy.

They are starting to gain traction in Australia.

A leading retailer has issued a bond linked to its move to renewable energy, while a telecommunications company has an issue linked to the rollout of solar panels at its retail stores.

Potential flaws

But sustainability-linked bonds have some important flaws that investors need to understand, says Ackman.

Probably the most fundamental flaw is the fact that if an issuer fails to meet the underlying environmental or social goal, the bond no longer meets the criteria to be called sustainable.

This means it has to be divested by most sustainable investment strategies just as the step-up coupon is due to be paid.

“We invest in these SLBs in our sustainable funds — if they don’t meet the target, we get a coupon step-up. But that means the bond is no longer tied to an environmental or social goal,” says Ackman.

“If it is no longer a sustainable bond, we cannot hold it in a sustainable strategy.”

Another emerging flaw is that the typical coupon step-up of 25 basis points made sense when interest rates were next to zero — but it may be less attractive to investors now that the general bond yields are higher.

A third problem is that some Australian companies are issuing bonds that are not sufficiently ambitious in scope.

“The federal government has a target for the grid to be 82 per cent renewable by 2030.

“If you are in a sector that can reduce emissions by changing where your electricity comes from, your corporate target has to be much more ambitious than the grid target.”

Find out about

Regnan Credit Impact Trust

Early days

Ackman says it’s the right time for investors to discuss how they want sustainability-linked bonds to adapt because its early days in the development of the product.

“It is still a novel idea and just because it is the way it is now doesn’t mean it is the only way it can be.

“What we are trying to do is safeguard this market.

“That means talking to arrangers before deals are shared and speaking in public forums about the things we’re not happy about with these structures.

“We want to make sure that these this structure doesn’t turn into greenwashing.”

About Murray Ackman and Pendal’s Income and Fixed Interest boutique

Credit ESG analyst Murray Ackman joined Pendal’s Income and Fixed Interest team in 2020 to provide fundamental credit analysis and integrate Environmental, Social and Governance factors across credit funds.

Murray has worked as a consultant measuring ESG for family offices and private equity firms and was a Research Fellow at the Institute for Economics and Peace where he led research on the United Nations Sustainable Development Goals.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team’s awards include Lonsec’s Active Fixed Income Fund of the Year (2022) and Zenith’s Australian Fixed Interest Manager of the Year (2020).

Regnan Credit Impact Trust is an investment strategy that puts capital to work for positive change.

Pendal Sustainable Australian Fixed Interest Fund is an Aussie bond fund that aims to outperform its benchmark while targeting environmental and social outcomes via a portion of its holdings.

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at November 16, 2022. PFSL is the responsible entity and issuer of units in the Regnan Credit Impact Trust (Trust) ARSN: 638 304 220 and Pendal Sustainable Australian Fixed Interest Fund (Fund) ARSN: 612 664 730. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund and Trust are available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or Trust or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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