The Bond Market’s Mispricing of Sustainability

    Stockholm (NordSIP) – Shortly before the cold took over Northern and Central Europe, we had the opportunity to talk to Founding Director Guy Cameron (left) and his colleague Keith Logan (right) from Scottish-based asset manager Cameron Hume. Together we explored the firm’s journey into sustainability and discovered what the bond market makes of sustainability matters. We looked at the strange case of Equifax bond yields and threw a critical glance at the green bond market.

    “Once we were talking to the investment arm of an Australian union,” starts Cameron, “and they explained to us how much pressure they faced from their members, to match the investment environmental and social standards the union stood for. So naturally, we went on to find the best way to tackle this problem, and provide a service with the type of accountability our prospective clients were looking for.” Like many other firms, Cameron Hume decided to rely on a third-party data provider like MSCI or Sustainalytics. “We needed to get data to measure exposure, and we wanted it to be independent. That’s why it was important to choose an outside provider,” explains Cameron.

    After this first contact with ESG data, the firm decided to go not one but two steps further. Cameron continues: “All the data was very equity oriented. So we adapted it to our bond universe. We integrated all the ESG parameters into our in-house bond database, which is also linked to market prices. Once we had the data accessible, we could make our portfolio managers and analysts aware of them. But what you want is to get them to think about broader issues before they make their minds up.”

    “If analysts look at a bond issue and say ‘I like the metrics, the issuer, now I check the ESG rating – is there any reason I shouldn’t invest?’ They have already made their mind up; it is difficult to talk them out of it. Instead, we show portfolio managers the exposures up front by colour coding all the issues. It may still be right to invest in a ‘red’ issue, but then you will know upfront that you will have to do the work, the other way round.”

    Cameron illustrates the principle of this bond selection method with the outstanding issues of consumer credit agency Equifax. “Last July,” Cameron reminds us, “the company experienced a major data breach, and only reported it in September. Credit agencies typically hold the sorts of information that you would want to steal someone’s identity, and the fact that they had kept it silent for so long was a huge issue.” In the aftermath of the news, several members of the board resigned, and management was replaced. The company is currently under investigation in the US and the UK, with the threat of fines or material sanctions. “The share price fell sharply, underperforming the US market by 25%,” remembers Cameron. “Bonds reacted on the event, but they have come all the way back since then. That is the curious part, and we see that happening all the time in the bond market.” The company may still face issues that qualify as ESG – in this case, they pose a social threat – but the bond market doesn’t price those in. Equifax’s bond issues are priced in line with similar issues of the same sector with a similar credit rating. “Conventionally, there should be a link between equity prices and spreads. But there is no such thing here. It is symptomatic of the whole market. ESG is not priced in.”

    If the market doesn’t seem to appreciate ESG on the downside, neither does it on the upside, one could argue. According to Cameron Hume’s research, the green bond market trades broadly in line with similar non-green bonds. “This market was created to allow the issuer and the investor to signal their intent,” Cameron explains. “The hope was that signalling would encourage investments in green projects. But from a fixed income perspective, the covenants are backed by the same credit as any other bonds. This is how the bond market operates: they are priced exactly the same as any other green bonds.”

    What is the problem? If investors can buy green bonds and not give up any return, why wouldn’t they? The problem is that the issuer is incurring a higher cost, given the need for additional documentation and a higher burden on reporting than any other non-green bond. “Ultimately, there may be a reputational benefit for investors, or even for issuers. I am not convinced that these reasons will be sufficient,” admits Cameron. The very essence of the bond market’s mechanism may altogether cap the growth of green bonds, and condemn them to remain a niche market, which would be a shame.


    Picture © NordSIP

    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

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