This article is part of NordSIP Insights – Sustainable Fixed Income Handbook. Read or Download the entire publication here.
With the rise in popularity of green bonds, industry labels and marketing efforts can muddle the waters and raise the spectre that among the multitude of securities flooding the market, some greenwashing might have escaped into the fray. Now that green bonds have become an accepted reality, asset managers need to be meticulous and quality-oriented in their investment process. These are the ideas echoed by Vishal Khanduja, Vice President and Portfolio Manager at Calvert Research and Management, responsible for managing the sustainable asset manager’s Green Bond Strategy.
The Sustainable Capital Disconnect
“I joined Calvert Research and Management in 2012, after working for seven years in the investment management arena as a portfolio manager at Columbia Threadneedle and associate director of fixed-income analytics at Galliard Capital,” Khanduja says. “Growing up and living in India, there were social and environmental issues that were not quantified, but which we were aware off needed to be solved. As I developed professionally, I became increasingly convinced that to solve any structural problems, such as these, requires channelling finances to address the issue,” he explains.
“Unfortunately, there is only so much that can be achieved through pro-bono or charity funds. These challenges require consistent and committed long term funding at a much larger scale, which can only be accessed through investors to facilitate the scale of change necessary to address these problems.” However, there was a disconnect between the problem and the solutions according to Khanduja. “Until I joined Calvert, I had not made the connection between sustainability problems and funding. I was aware of microfinance solutions, but those were still very niche and new and inaccessible to the majority of investors.”
“Joining Calvert really was that ‘light bulb’ moment. It helped me realise that a solution was available to provide sustainable solutions and financial returns,” he adds. “It showed me it was possible to combine fundamental credit work with additional layer of information from financially material ESG factors provides a more complete assessment of the issuers’ risks and opportunities. It just makes prudent investment sense.”
Sustainable Fixed Income Challenges and Opportunities
According to Khanduja, there have been three main drivers of growth in sustainable fixed income, which share in common, the fact that all members of society have become more aware of existing problems. “Practically, speaking, the increased incidence and violence of extreme climate events, such as flooding, hurricanes and forest fires, have made companies more cognisant of the scale of financial impact from climate change.”
“From an analytical perspective, there is also more and deeper research, information available now to help investors quantify the materiality of sustainable factors to financial returns. Put another way, there has to be a significant (and positive) impact to the ESG impact made by the firm.
From the investor point of view, the increased awareness has left asset owners, such as pension funds, wanting to internalise this new information into their investment decision making to make a long term impact on the sustainability of the planet,” he adds.
“If it is done right, the sustainable fixed income market is a very effective pathway to efficiently finance transition to a less carbon intensive economy. The challenges faced by the Green Bond market have changed as the market matures,” Khanduja explains. “A few years back, the main challenge was the inability or unwillingness to issue green bonds, as well as spotty overall Green Bond liquidity.”
“Although there were some issues at the start of the year due to COVID19, Green Bond issuance has rebounded nicely since then. According to the Climate Bonds Initiative, we now have over 1,000 issuers, which provide orders of magnitude more liquidity than before and argues for increased future growth.” According to Khanduja, the issue is no longer one of quantity, but rather of quality. “Now, the challenge is to ensure investors are doing their work to assess issuers’ overall ESG profile rather than just taking every labelled Green Bond.”
The Calvert Green Bond Strategy
“The need for a focus on quality and selectiveness is at the core of the Calvert Green Bond Strategy”, Khanduja argues. The Green Bond strategy was launched in 2011 by Khanduja‘s co-portfolio manager Brian Ellis and the then CIO of Calvert to model the strategy to provide exposure to green and impact bonds while also delivering a strong total return fixed income profile. The two portfolio managers who are supported by over 50 other investment professionals, including fundamental credit analysts, ESG analysts, fixed income traders, and other PMs. The ESG research is performed by Calvert’s dedicated ESG Research team based in Washington, DC.
“We seek income-producing investments in global fixed income markets that are working directly to move to a less carbon intensive economy. Although there are over US$2 billion in total green bond AUM (inclusive) across all Calvert Fixed Income strategies, this specific strategy manages a portfolio of approximately US$650 million,” he says. The strategy is available as a separately managed account to institutional investors in the Nordics and globally. “We plan to have a UCITS vehicle ready sometime in 2021,” Khanduja adds.
The strategy doesn’t have a preference for any single type issuer or impact profile for a green bond, he explains. “First and foremost, we assess how an issuer is managing its overall financially material ESG risks and opportunities, and then we independently evaluate the green bond itself on the strength of its project or purpose, the fundamental credit of the issuer and the relative value of the issue and sector.”
Another resource available to investors is the work of the Calvert Institute for Responsible Investment, which helps to evolve Calvert’s ESG research process. “The mission of the Institute is to catalyse positive change through our research and the sum of our actions,” Khanduja says. “This is accomplished through conducting and publishing industry-leading ESG research with internal and external investment and academic partners, as well as through the efforts of other Institute programs. The Institute serves as a consortium of experts in the field of responsible investing, providing ESG research and thought leadership for investors, corporations, and policy makers.”
Value Beyond Labels
The Calvert Green Bond Strategy’ investment process is based on the belief that risk-return potential can be improved through active positioning in security selection, sector allocation, duration, and yield curve, according to Khanduja. “The alpha generated from these sources is most reliable when focusing on long-term risk-adjusted returns. This requires risk management to be considered throughout the process, from a security’s purchase to its sale.” According to the portfolio manager, this is when ESG integration comes into play. “When capturing specific investment opportunities, downside risk can be mitigated through strong knowledge of underlying asset values. Integrating financially material ESG information with fundamental credit analysis provides, in our view, a more complete assessment of an issuer’s long-term value.”
The strategy combines macro and microeconomic analysis to inform its investment decisions. “Our top-down process evaluates macroeconomic performance and expectations against our monetary and fiscal policy expectations. This drives our duration and yield curve positioning,” Khanduja says. “We then assess the fundamentals of three broad categories of economic balance sheets: sovereign, corporate, and consumer. This informs our broad views on sector allocation, which are then more granularly informed by our bottom-up security selection at the industry level. While our top-down view is essential, a larger part of the investment process is focused on bottom-up analysis.”
“Once our broad sector allocation preferences are established, we rely on our team of ESG and fundamental credit analysts to generate the best risk-return ideas in those sectors.” According to the portfolio manager, ESG analysis allows him to focus his investment universe. “This opportunity set is further refined allowing us to choose only those securities which meet our ESG criteria and our proprietary green bond criteria.” However, Khanduja’s options are not limited to bonds labeled as green by third-party providers. “Instead, our ‘Three Pathways to Green’ research process focuses on green projects, solutions providers, and environmental leaders that we independently review through our proprietary green bond analysis. We focus on their issuance history and consider their ability to tackle their bonds’ target environmental challenges.”
These considerations notwithstanding, the strategy’s assessment is conducted on an ongoing basis and investments are differentiated depending on their financial and ESG performance, according to the portfolio manager. “In the portfolio construction process, ESG factors may affect how views are ultimately expressed. For example, an issuer with poor or significantly weakening ESG performance may warrant a shorter duration position and/or one with more seniority in the capital structure. While the core of our investment process focuses on those issuers that are adequately managing their material ESG risks and opportunities, portfolio managers will further tilt the portfolio towards those issuers with better overall ESG performance and impact metrics consistent with fiduciary goals.”
A Safe Haven
“The twofold goal of the strategy is to provide both a strong fixed income risk adjusted returns while also providing impact/green exposure. It has performed within our expectations.”
The quality of the green bond portfolio also appears to have paid dividends during the crisis. “The strategy has performed well during the crisis as the high-quality nature of the strategy means that it benefited from the global flight-to-quality move in the first half of 2020,” Khanduja concludes.
*Past performance is not a reliable indicator of future results.
Source of all data: Calvert Research and Management, MSCI, 30/09/2020, unless otherwise stated.
ICE BofAML Green Bond Index tracks the performance of securities issued for qualified “green” purposes. Qualifying bonds must have a clearly designated use of proceeds that is solely applied toward projects or activities that promote climate change mitigation or adaptation or other environmental sustainability purposes as outlined by the ICMA Green Bond Principles. General debt obligations of corporations that are involved in green industries are not included. The index includes debt of sovereign, quasi-government and corporate issuers, but excludes securitised and collateralised securities. Qualifying securities must have an investment grade rating, at least 18 months to final maturity at the time of issuance, at least one month remaining term to final maturity as of the rebalancing date and a fixed coupon schedule. Qualifying securities may be denominated in specified developed market and emerging market currencies. Securities denominated in a qualifying emerging market currency must settle on Euroclear.
Debt securities are subject to risks that the issuer will not meet its payment obligations. Low rated or equivalent unrated debt securities of the type in which a portfolio will invest generally offer a higher return than higher rated debt securities, but also are subject to greater risks that the issuer will default. Unrated bonds are generally regarded as being speculative.
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This material is presented for informational and illustrative purposes only and should not be construed as investment advice, a recommendation to purchase or sell specific instruments, or to adopt any particular investment strategy. This material has been prepared on the basis of publicly available information, internally developed data and other third party sources believed to be reliable, however, no assurances are provided and Eaton Vance has not sought to independently verify information taken from public and third party sources. Information contained in this material is current as of the date indicated and is subject to change at any time without notice. Future results may differ significantly from those stated, depending on factors such as changes in instruments or financial markets or general economic conditions
Specific instruments, sectors and portfolio characteristics mentioned are included only to provide a snap-shot illustrative sample based upon the portfolio manager’s current investment strategy as of the date indicated The strategies and views (if any) described may not be suitable for all investors. Investing entails risks and there can be no assurance that Eaton Vance, or its affiliates, will achieve profits or avoid incurring losses.
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