Sustainable fixed income investors have to thread a complicated line between being at the forefront of impact while overcoming fears that their investments are conducted at the detriment of financial returns. However, no such trade-off is necessary according to Simon Bond, Executive Director in charge of the Responsible Investment Portfolio Management at Columbia Threadneedle Investments.
With over 35 years in the field and responsible for developing and managing Columbia Threadneedle’s suite of UK, European and Global social bond funds, the manager is confident in the ability of fixed income markets to support global social charge. Whether as an investor or as a member of the community pushing for better and clearer standards, through labelled or general-purpose fixed income securities, the role of fixed income investors is crucial in pushing society towards a fairer future.
Pioneering Social Bonds
According to Bond, Columbia Threadneedle’s original social fund was set up in response to a unique request. “The Big Issue, a street newspaper, approached us nearly 10 years ago to set up what came to be the Threadneedle UK social bond fund. They wanted a product that shared their values of advancing social good by getting people to work rather than through charity.”
“We worked together to define seven types of social needs and associated desirable social outcomes, an approach founded on Maslow’s hierarchy of needs1 that remains a foundation of our investment process. Our second task was understanding how those social outcomes could be delivered through fixed income investments. Their request reminded me immediately of the Peabody Trust Housing Association, which was set up to provide housing for the London poor, as part of the legacy of George Peabody, an American Victorian philanthropist. I had come across their work 20 years prior to the Big Issue’s query and it was my first encounter with the idea that it is possible do good while earning a financial return,” Bond says. Inspired by the example of the Peabody Trust Housing Association, the Columbia Threadneedle social bond strategy focused on housing associations, universities, the Wellcome Trust, and such organisations.
The resulting Threadneedle UK Social Bond fund was the first of the franchise and preceded the International Capital Markets Association’s Green and social Bond Principles. According to Bond, the fund received seed investments in December 2013[1] before the remaining investors joined in January 2014. “When we were talking about how we develop the social bonds within ICMA in 2016, I was the only manager on the committee that actually had a social bond fund set up and buying bonds. This was one year before we issued the guidelines ahead of the actual publication of ICMA’s social bond principles in 2017,” Bond explains. The fund Theadneedle (Lux) European Social Bond was launched in 2017, followed by the Global Social Bond mandate in 2018.
What is a Social Bond?
According to the portfolio manager, a social bond is a bond that delivers for society, in addition to generating a financial return. “The fund rejects preconceptions that doing good requires foregoing financial returns. We think it is possible to do both. We think that if you take the corporate bond risk, you should get a corporate bond return. No sacrifices are required. But on top of the financial return, a typical social bond also delivers for society in at least one of the target areas defined by our social partner,” Bond explains.
Columbia Threadneedle’s social bond funds follow their own pioneering path. “We don’t just exclude sectors and issuers. Having started before ICMA came up with its principles, we’ve always invested beyond ICMA-branded social bonds, including standard, general-purpose bonds. We buy any bond whose funds we can follow through the use of proceeds and identify through evidence that they generate a net good to society. We’re looking to optimise what we call social alpha – the good that we do for society,” Bond explains.
Championing Social Investments
The fund Threadneedle (Lux) European Social Bond’s investment process is illustrative of the approach taken by Columbia Threadneedle’s suite of social bond funds. As a first step, the fund applies a series of minimum standards to ensure the bonds selected are fit for purpose, including the exclusion of companies in violation of international conventions, polluting or socially detrimental industries, and controversial entities.
The goal of the fund is to support projects that help people overcome hurdles along Maslow’s hierarchy of needs. “One of the key elements in the filters applied by the fund is the Social Needs Category, which flows from a social hierarchy-of-needs approach, whereby more primary and basic needs (e.g.: affordable housing, healthcare) are prioritised over more general need investments such as infrastructure projects,” Bond adds.
According to the fund manager, investments are also mapped onto the UN Sustainable Development Goals (SDGs). Although the fund targets all SDGs, it has mainly impacted SDG 11 (“Sustainable Cities and Communities”), SDG 9 (“Industry, innovation and Infrastructure”), SDG 8 (“Decent Work and Economic Growth”) and SDG 7 (“Affordable and Clean Energy”), according to Bond.
Constructing the Social Bond Portfolio
Columbia Threadneedle sought to do three things in portfolio construction for this fund. “First, we want to optimise social benefits for society. We also want to deliver a financial return that matches the risk investors are taking. Lastly, this is a daily priced fund, so we need to ensure liquidity,” Bond says. These objectives have an important effect on some of the fund’s investment preferences.
“When the fund was launched, our thought was that a social bond was just a corporate bond with two additional covenants. The use of proceeds covenant ensures that the money goes only to predefined projects, while the information covenant ensures annual reporting on the impact of the money spent. Given this perspective, social housing bonds are a natural target of the fund. The very first social bond after the publication of ICMA’s social bond principles was issued by BNG [2] for social housing in the Netherlands. Given my early experience, the first entity I considered was the Peabody Trust Housing Association, whose bonds we still hold in our portfolio. Housing is a primary need at the top of Maslow’s hierarchy of needs,” Bond continues.
Originally, the social bond fund did not invest in government bonds. “We didn’t know where the money was going. Actually, we knew that some of that money was going to areas we didn’t want it to go to like conventional and nuclear weapons. But when, Poland, France, Spain, the UK, and other countries started issuing green bonds, this opened the door to us using government, agencies and supranational bonds that deliver for society for liquidity purposes,” Bond adds.
“Green bonds allow us to buy government bonds because we know where the money is going to be spent. Earmarked government bonds are very useful to ensure the liquidity of the fund. They are net positive for society and they are very easily traded,” Bond continues.
According to the fund manager, the introduction of green and social government bonds also creates broader opportunities than those available in equity markets. “The opportunity set is much, much wider in the bond market than what would be available in the equity market. Entities issuing bonds, such as charities, local authorities, agencies, supranationals, governments, allow investors to gain exposure to projects that are unreachable through common equity,” he argues.
Monitoring Intentionality and Social Quality
The fund manager is keen to emphasise the importance of independent oversight. To this end, an independent Social Advisory Panel oversees the funds’ investments and ensures that management is consistent with the funds’ social purpose. “We report to the Social Advisory Panel every quarter on our exposure to each particular area of social outcome through our inhouse social categorisation of intentionality and intensity scores.”
According to Bond, the fund performs its own scoring of each investment opportunity, evaluating the social characteristics and expected impact of each bond in two parts. Bonds receive a letter grade assessing the intentionality of the bond. The letter grade assessment defines Impact Categories ranging from A to C.
“Category A bonds are said to have a ‘social impact’ and the funding is designed specifically to generate positive social impact, development or change. Category B bonds are said to be ‘investments with impact’ and fund projects likely to generate expected and identifiable social impact for individuals, either indirectly or without specifically disclosed intentionality. Category C bonds are said to be ‘development finance & global impact Investments’ and that support capacity, infrastructure and other sources of positive social externalities. The structure of the scores echoes our preferred hierarchy of needs so that investments in social housing get slightly higher scores than those in health or education, which themselves score higher score than infrastructure,” Bond explains.
“Lastly, fixed income securities also receive a numbered grade assessing their quality and depth. The numbered grade generates an Intensity score, from 0 to 31, which translates into an Intensity rating ranging from 1 to 4, 1 being Strong and 4 being Minor,” Bond continues.
Deprivation, Deeper Impact and Engagement
According to Bond, the funds’ seven social targets are driven by a preoccupation with the mitigation of deprivation and the promotion of impact. “Given the geographical dispersion of our investments, we had to take an approach that provided a meaningful understanding of deprivation, deprived constituents of society and deprived communities. Our approach echoes the research of Wilkinson and Pickett [3], which considers that deprivation, as a concept, is best understood as a relative within-country effect. People don’t feel deprived relative to somebody on the other side of the continent. They feel deprived relative to their neighbours,” the fund manager says.
“The bond market allows investors to focus on outcomes and impact in very specific ways. Equity investors generally operate in the secondary market. Their investments can help with price discovery and signal the quality of the investment, but they don’t actually achieve the impact that buying a bond when it is launched does. Primary bond market investors are able to leverage the funding needs of issuers during auctions and syndications, a time when borrowers are likely to be most responsive and receptive to the demands that social bond investors looking to make an impact,” Bond argues.
According to Bond, investors in sustainable fixed income securities also need to dig into the details, engage with the use of proceeds and with the issuing entities. “The motto of the property market is ‘location, location, location’. The focus on this particular side of the market needs to be ‘engagement, engagement, engagement,” he adds.
“Our opportunity to engage with companies tends to be strongest when issuers want something. In this sense, engagement opportunities coincide with impact opportunities. Sustainable fixed income investors focus on new issues because that’s when we can be more impactful. This is when investors have to roll up their sleeves, ask difficult questions and engage with borrowers,” he continues.
Investors such as Bond can also contribute by participating in a number of advisory bodies looking to set new guidelines and principles. Bond, for example, sits on the Advisory Council for the impact investing Institute, which was set up by a UK government task force in 2018. He’s also on the Social Bond Principles Committee of the ICMA and was an enthusiastic campaigner for the development of the UK sustainable government bond market, including the green gilt a campaign for which he launched in May 2019.
“There’s quite a lot that goes on under the radar. It is not just about running a fund. We are not simply buying bonds. We are trying to change the market and encourage issuance and origination, helping banks structure bonds in a way that makes them fit for the purpose of targeting social good,” Bond concludes.
