When investing to help effect climate transition, the influence of bonds should not be underestimated, says Samuel Grantham, investment director, Fixed Income, at abrdn.
Climate change is the biggest challenge of our generation and in order to achieve real climate progress, we believe it requires investing in more than climate leaders and green bonds but investing in the transition. We seek to invest in companies that are not yet green but have plans to improve climate performance.
We’re often asked if bond investors can influence the climate transition as effectively as equity investors.
After all, equity shareholders have company ownership stakes, allowing them to influence corporate governance and strategic direction. There’s also the argument that the interests of equity investors tend to align more closely with a company’s long-term objectives and sustainability goals.
While it’s true that equity investors may have direct effect, we believe the influence bond investors can wield should not be underestimated.
Real-world impact
Bond investors enjoy the flexibility to invest across both corporate and sovereign landscapes.
A prime example is our investment in a government-sponsored rail network in Chile. Rail travel is a more environmentally efficient alternative to personal car usage. It therefore plays a major role in reducing greenhouse gas emissions. This particular investment is government-owned and operated. That means the government finances around two-thirds of the project, with the remaining third via the public debt market.
Through our bond purchase, we’re supporting a vital part of the Chilean economy and helping provide financing for low-carbon transport. Our investment has the potential to generate a reliable income for our clients while helping to cut emissions and reduce air pollution.
Driving change in vulnerable regions
Then there’s India. As one of the world’s largest coal consumers, the country faces significant environmental challenges, including deforestation, habitat destruction, and air contamination. Transitioning to renewable energy sources is crucial for India to mitigate climate change impacts and reduce pollution.
Corporate bonds present viable opportunities for investment in private Indian renewable energy companies, which are not typically accessible in the equity space but have public debt outstanding. This helps investors effectively channel capital into crucial sectors, reducing capital costs for companies leading the energy transition. In doing so, investors can help drive positive environmental change in vulnerable regions like India.
Sustainability-linked bonds
In recent years, sustainability-linked bonds have become increasingly popular. These are debt instruments whose financial characteristics are based on whether the issuer achieves sustainability goals.
It must be noted that there are controversies around these instruments, such as inadequate consequences for non-compliance and poor disclosure of key performance indicators.
Nonetheless, when properly structured, sustainability-linked bonds can incentivise companies to meet targets. They utilise legal agreements and the prospect of higher financing costs to ensure companies adhere to their environmental goals. As with all investing, careful selection is essential.
The benefits of a direct approach
It’s important to highlight the role of primary markets in fixed-income investment. Investing through new issuances means directly providing cash to companies and creating a financial transaction.
This direct exchange is more common in bond investing than in equity investing. The latter involves buying shares from another investor. Direct transactions with the company are less frequent.
In our view, a direct investment approach can bolster sustainability efforts, ensuring funds are channelled into projects with clear strategies.
Adaption
With adverse weather devastating regions worldwide, the need to build climate resilience into economies is clearer than ever.
There’s a wealth of projects in which to invest, ranging from climate-resilient housing and biodiversity corridors to flood-plain restoration and the development of drought-resistant crops.
The battle against global warming demands a multi-faceted approach. Investors in bonds, equities and other asset classes can all play vital roles while targeting positive returns. Given the scope for steady income streams and the potential to channel finance directly into key projects, we believe climate-focused bonds are well worth adding to portfolios.
Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.
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