This article is part of NordSIP Insights – Impact Investing Handbook. Read or Download the entire publication here.
Since the creation of the World Bank’s International Bank for Reconstruction and Development (IBRD) at the end of World War II, Multilateral Development Banks (MDBs) have spent the last 76 years testing and fine-tuning the impact investing tools necessary to help the world grow out of poverty.
The creation of the UN Sustainable Development Goals (SDGs) in 2015 and the recent needs emerging out of the COVID-19 crisis have ensured MDBs remain relevant to tackle the world’s most pressing needs. For private investors, such relevance has translated into continued liquidity and has facilitated the partnerships necessary to allow the private sector to contribute to development goals while sheltering themselves under the creditworthiness of these institutions. This is patent in the continued popularity of indices and ETFs allowing investors to tap into these impact opportunities.
Multilateral Development Banks
MDBs, also known as multilateral lending institutions (MLIs), are supranational financial organisations specialised in the provision of financial support and know-how for economic and social development projects. MDB bonds can be classified as a form of impact investment because the capital acquired from the issuance of these bonds is channelled to social as well as physical infrastructure such as roads, railways, bridges, telecommunication, water management facilities, solar and wind farms, schools and hospitals.
Structurally, the ownership of these institutions is shared between multiple member states, whose stakes are represented by a share of votes and a share of callable capital, often proportionate to GDP. Although some MDBs provide outright grants, the main focus of these institutions is to ensure the long-term development of the countries they intervene in. While they are not purely profit-driven, MDBs see profit as a signal of the competitiveness and long term viability of the projects they invest in.
Although lending criteria are determined prudently, the nature of conditions on the ground in the markets where MDBs operate is such that these projects are not risk-free. Therefore, an important aspect of MDBs is their status as “preferred creditor”, which gives them priority over all other creditors. Additionally, they enjoy strong guarantees by G7 countries and other highly-rated sovereigns. Although MDB bonds generally offer slightly higher yields compared to US Treasuries, member states’ assurances guarantee that they are extremely reliable creditors, which are often perceived as safe-havens. As such, they can be seen as a “sustainable alternative” to high-grade government debt.
Investing in MDBs
For investors interested in contributing to the impact investments of MDBs, ETFs offer a simple and accessible path to tap into the work and returns of MDBs, through bond benchmarks such as the “Solactive UBS Global Multilateral Development Bank Bond” index family, introduced in 2018. The Solactive UBS Global Multilateral Development Bank Bond USD 25% Issuer Capped Index, for example, focuses on MDB fixed rate bullet or callable international bonds, rated no less than AA- (S&P) or AA3 (Moody’s). The index is denominated in US Dollars and invests in bonds with a minimum of US$500 million outstanding and more than 12 months to maturity. Each issuer is weighted by market capitalisation and capped at 25% of the index.
For impact-minded investors, UBS has created the “UBS ETF (LU) Sustainable Development Bank Bonds UCITS ETF”, which replicates the above-mentioned benchmark and provides a diversified exposure to sustainable bonds issued by IBRD, International Finance Corporation (IFC), Inter-American Development Bank (IADB), the International Development Agency (IDA), the European Bank for Reconstruction and Development (EBRD), the African Development Bank and Asian Development Bank (ADB).
MDBs and COVID-19 Impact
2020 has provided a test of the relevance and strength of MDBs. In the face of the pandemic, global MDBs were some of the first to react to the crisis. As early as March, institutions such as the World Bank’s IFC were coming to the market to issue social bonds, the proceeds of which were to be channelled to dedicated programs designed to assist the most exposed developing countries. Other organisations followed suit, including the AfDB, the IADB, the European Investment Bank (EIB), the EBRD and the IBRD.
Not only do MDB bonds offer investors a possibility to achieve positive social and economic impact, they also provide a way for them to diversify their portfolios. During the March sell-off this year, high-grade bonds (such as US Treasuries) lost all their previously accumulated returns of the year. As a result, their performance contribution to a diversified portfolio was close to zero. In contrast, the MDB bond index currently offers higher returns compared to duration-matched US Treasuries with an option-adjusted spread of 11.4 bps (September 2020). The option-adjusted spread spiked to new historical highs of almost 60bps at the end of the first quarter 2020, as the COVID-19 shock rocked financial markets leading investors to sell en-masse.
The strong credit rating allowed investors to maintain their confidence on MDBs as a suitable investment during market turmoil. The safe-haven status of MDBs is patent in the consistent downwards path of the MDB index’ yields-to-maturity as well as the strongly positive index performance since the beginning of 2020.
While MDB bonds have a direct impact in supporting developing countries to cope with the pandemic their positive total returns also helped investors cushion against the losses from risky assets. The high credit rating makes multilateral development bank bonds a liquid and low-risk form of impact investing while offering true global diversification through the unique reach and variety of MDB activities across most of developing countries.
Picture credit: 9_fingers_ for Twenty20
