Moira Gorman and Tammie Tang highlight pioneering social and environmental impact opportunities for pension investors
Focus is a publication that aims to bring you face-to-face with a selection of key investment managers, advisers, and providers from across the institutional pensions market.
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2020 was a year that highlighted a myriad of social and environmental issues as the polarising effects of Covid-19 on individuals became apparent. It is no surprise then that more institutional investors in 2021 are demanding investments that have a sustainable edge and offer returns that can positively impact the people and world around them.
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IMPORTANT INFORMATION
This style of impact investing is not new. However, the surge in volume of newly issued debt based on environmental, social and governance principles over the past year has propelled investors to consider fixed income to access this style of investing. The opportunity in this asset class alongside the targeted nature of social and green bonds has seen it ‘come of age’ in terms of responsible investing.
In this guide, Professional Pensions and Columbia Threadneedle Investments explore the power of credit in supporting the social and green agenda as pension schemes look to increasingly consider the environmental impact of their portfolios. We also explore the role of fund managers like Columbia Threadneedle in helping pension schemes manage and reach their long-term sustainable goals.
Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Your capital is at Risk.
This material is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. The mention of any specific shares or bonds should not be taken as a recommendation to deal.
This document includes forward looking statements, including projections of future economic and financial conditions. None of Columbia Threadneedle Investments, its directors, officers or employees make any representation, warranty, guaranty, or other assurance that any of these forward-looking statements will prove to be accurate. The analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.
Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.
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Tom Moulds and My-Linh Ngo on impact-aligned debt investing
Can debt investors promote positive change in the world by investing in the expanding ‘sunrise’ industries of a sustainable future rather than the ‘sunset’ industries of our past? If so, where would this approach sit in the ever-broadening spectrum of sustainable investing strategies?
In this Focus, My-Linh Ngo, BlueBay’s Head of ESG Investment, and Tom Moulds, a senior portfolio manager, tell us how they came to design BlueBay’s first impact-aligned debt strategy. The world is in a race against time, and Ngo thinks that an impact-aligned stance could speed up our transition to a low-carbon, more socially responsible society.
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Sustainable bonds
Fixed income investing with
Name xxxxxx xxxx xxxxx xxxxxxx
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Delivering sustainable goals
Decarbonising portfolios
For Columbia Threadneedle, the growth of this section of the fixed income market is nothing new. The group has been a leader in impact investing for close to a decade and has been a pioneer in social impact credit investing as well. During that period, the team has built a well-established and tried and tested process around an assessment of the intensity of social impact.
Social impact intensity
investments in green, social and sustainable bonds.
nstitutional investors have long used fixed income markets to generate alpha and risk-adjusted returns, but more recently the demand for investments to have a sustainable edge and positively impact the world has resulted in strategies which support
I
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Addressing social deprivation and inequality is a really important way to advance society
Covid-19 shone a light on fixed income investments that can generate positive financial returns AND positive social or environmental impact. For Columbia Threadneedle’s Tammie Tang, the growth of this market has been a long time in the making
Last year saw over $500bn of “specific use of proceeds issuance”, which encompasses social bonds, green bonds, and sustainability bonds, according to Bloomberg data. This included an 894% year-on-year growth in the issuance of social bonds, up from 2019’s then-record $18bn, with 2021 issuance of the instruments already hitting $160bn as of 26 July (see graph below).
The figures are unsurprising given how Covid-19 exacerbated social inequality across the globe in 2020 and resulted in a growing cohort of issuers trying to fund solutions to the challenges society faces. Tapping the bond market are fund managers looking to build and maintain affordable housing; to enable or protect sector level jobs; to aid delivery of essential medical supplies; or to disburse and provide vaccines globally.
positive social
environmental impact
and
Tammie Tang, credit portfolio manager for institutional clients, says this role has become ever more essential in 2021 as asset owners including insurers and pension funds increasingly require help to meet their financial objectives while also targeting non-financial, sustainable goals.
Specific use bond market growth
1
Source: 1: Bloomberg and Columbia Threadneedle Investments EMEA APAC as at 18 May 2021
The team’s social investment philosophy is built on the belief that investing in businesses that have positive social impact is the right thing to do, and that investors can do a lot of good for society without having to sacrifice financial returns.
“Investments in impact funds are deemed eligible only if there is strong evidence of positive social impact (or ‘intensity’) and if the issuer also meets our required standards for investment from a pure financial perspective. Studies do show that addressing social deprivation and inequality is a really important way to advance society both in economic terms, as well as welfare and well-being,” Tang says.
Tang’s team targets key areas such as housing, health and social care, education and skills, employment and training, utilities and the environment, financial inclusion, and community services. Investments in these areas have greater impact according to the social outcome areas targeted, the social geography, the population targeted and specific use of finance.
Explaining the financial assessment component of her team’s investment approach, Tang says the investment philosophy is built around high-quality, bottom-up issuer and issue selection as a primary means to deliver repeatable returns. As the attraction of each fixed income area can change as economic and credit cycles progress, using an actively managed approach is how she brings consistent financial value and real social impact to investors’ portfolios.
Financial returns
“Our investing philosophy is built on in-depth issuer and issue selection. This is what our clients want because it can deliver a really consistent, high risk-adjusted return.”
Key social outcome areas of focus
Housing and Property
Health and Social Care
Education Learnings and Skills
Transport and Communication
Utilities and the Environment
Financial Inclusion
Employment and Training
Community Services
While the team’s core goal is generating alpha for institutional investors through risk-adjusted issue selection, building sustainable impact into the credit strategy is now a key focus. Clients are increasingly focusing on sustainability objectives such as a move to net-zero carbon or a greater social impact focus.
Race to net zero
Columbia Threadneedle’s credit team has also built on its existing process by embedding carbon considerations into its investment research process and portfolios. The team can assess a portfolio’s carbon trajectory and for clients with carbon targets, they can construct credit portfolios using companies with stronger business models and balance sheets and with lower carbon emissions assessed on a forward-looking basis.
“For example, we can seek to optimise the portfolio by switching out of a higher carbon company with weaker balance sheet and tighter spread, into one with wider spread, stronger balance sheet and lower carbon,” Tang explains.
Through its social bond franchise, the group partners with social experts whose job is to advise, independently assess, and validate the group’s assessments of the impacts made by individual investments. One of the main partners for the social bond franchise is The Big Issue, one of the longest running advocates of entrepreneurship for homeless people in the UK.
Columbia Threadneedle’s social impact credentials
Columbia Threadneedle is a funder and founding member of the Impact Investing Institute, which works to harmonise impact investing standards and metrics as well as promote impact investing strategies.
For Tang, the rapid growth in demand and issuance of this market has been driven in part by global standards created by organisations such as the International Capital Markets Association. These provide a framework to support the impact bond market, including recommended practices for monitoring the use of proceeds and reporting, says Tang.
Growing role of impact bonds
“For example, proceeds from impact bonds cannot be used for general corporate purposes and must be specifically used to fund projects such as shelter, jobs, healthcare, or immunisations. These foster confidence in the market and pave the way for future growth.”
But she also believes the fixed income market will have a “powerful role” in helping more than 100 governments achieve their ambitious pledges to reach net-zero greenhouse gas emissions by 2050 or sooner.
Thus, we believe the credit and fixed income markets will serve a much, much greater role in enabling impact in supporting the social and green agenda, and impact investments will no longer be confined to minor portions of allocations within equities or private credit, she says.
Moreover, the objectives of tackling climate change and making a social impact go hand in hand, Tang argues: “By investing in green bonds, for example, to support the transition away from fossil fuels, asset owners can support people and societies. The issues are not distinct in our view, and indeed the definition of sustainability encompasses addressing both green and social issues.”
This kind of ‘impact investing’ is conventionally defined in private markets in terms of whether the investment makes a tangible, measurable difference that is ‘additional’, in that it would not have occurred without the investor’s intervention.
But that’s a lot easier to claim when investing in, say, the equity of a risky start-up, than when investing in the liquid debt of a more mature company through the secondary debt markets – even though sustainable ventures may need both forms of capital during their life-cycle in order to thrive.(1)
Public debt markets need to help companies that are actively promoting sustainability to scale up
The seven themes:
THE INTERVIEW
Emerging markets were still able to cut rates and stimulate that way
environmental
impact
The process to true ESG integration can be long, complex and difficult for pension schemes - which is why TwentyFour Asset Management has re-aligned its investment thinking to help schemes on their sustainable journey goals
their investment strategies, it is not difficult to list why. Over the past decade businesses, individuals and most importantly consumers, have woken up to the fact they can make a monumental difference to the planet if their investment strategy is well tuned to key sustainable risks like climate change and social inequality.
hen it comes to the reasons behind pension funds increasingly seeking to include environmental factors in
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Tammie Tang, director, fixed income portfolio manager, Columbia Threadneedle Investments
Sustainable Bonds
Tammie Tang and Moira Gorman, Columbia Threadneedle Investments
DELIVERING SUSTAINABLE GOALS
A net zero-targeted case study
Leading the way to help
pension schemes reach their sustainable goals
Pension schemes are increasingly considering the environmental impact of their portfolios and adopting alignment to net-zero carbon pathways. But how are fund managers working with schemes to help them align their investments with their net-zero goals, and understand how realistic their targets are?
What has been less obvious is how to align assets with rapidly evolving sustainability-driven investment values and objectives – whether environmental, social, or both. Whilst there is a greater choice of funds on offer for those seeking sustainable investments in 2021, ensuring pension schemes are appropriately aligned and not at risk of becoming victims of issues like greenwashing requires a well-thought-out strategy that will stand the test of time.
consumers, have woken up to the fact they can make a monumental difference to the planet if their investment strategy is well tuned to key sustainable risks like climate change and social inequality.
hen it comes to the reasons behind pension funds increasingly seeking to include environmental factors in their investment strategies, it is not difficult to list why. Over the past decade businesses, individuals and most importantly
It is a service that has become a core part of Columbia Threadneedle’s offering in 2021 to align with clients' sustainability objectives.
A growing number of pension schemes are looking at delivering impact through part of their bond portfolio specifically, and they are realising that the opportunity offered through this asset class to achieve their broader sustainable goals can be far more impactful.
Moira Gorman, sales director for UK pension funds at Columbia Threadneedle, explains: “Rather than delivering impact through the small exposure represented by their equity portfolio, we believe pension funds can use the bulk of the assets, that is their bond portfolio, to deliver social and environmental outcomes, while delivering their financial targets,” Gorman says. “This is because investment-grade corporate bonds across the duration spectrum offer a much greater sustainability targeted investment opportunity.”
Moving a £100,000 pension pot with a traditional portfolio which includes oil and gas companies, to a positive impact portfolio is the equivalent of taking five or six cars off the road every year*
*Source: The Path, February 2021
One of the key reasons why the sustainable bond market is growing is the recent crop of regulations around net zero targets globally which aim to support the transition towards sustainability post-Covid-19.
Net zero commitments
In response, larger pension schemes are also making commitments to reduce the carbon emissions attributable to their investment portfolios to net-zero by 2050 (see boxout below).
“The challenge for asset owners is understanding whether they can expressly commit to net-zero by 2050, as well as credible interim targets, and while not compromising financial returns,” says Tammie Tang, a credit portfolio manager for institutional clients at Columbia Threadneedle.
Tang’s team is working closely with clients to align their investments with their net-zero goals, using data and analytics to help them understand how realistic these targets are.
“Using the level of interim targets that sovereigns are setting, as but one guide, suggests that clients could consider cutting at least or in excess of 5% emissions per annum, roughly,” Tang says.
The team evaluates a combination of forecast carbon trajectories and active bottom-up issuer analysis to support clients' carbon reduction targets.
1) Utilising a ‘data lake’ and advanced analytics
The Columbia Threadneedle carbon analysis process
Forward-looking carbon trajectories
2) Extracting carbon trajectory estimates with confidence bands
3) Supplementing these with in-depth thematic research to assess underlying historical and forward-looking drivers
1) Research intensity allows us to screen for companies with stronger business models and balance sheets, lower future carbon trajectories and better valuations (ie, wider credit spreads)
2) Active positioning takes greater prominence according to (a) market opportunities, (b) strength of carbon reduction forecasts and (c) active engagement
Active Issuer-level analysis
By utilising its large, well-resourced ‘data lake’ which captures an extensive set of financial and non-financial data for a wide spectrum of companies, and together with advanced machine-learning models, the group has forecast scenarios towards the expected natural rate of carbon decline within a credit portfolio, as well as forecasts at higher or lower levels of confidence.
These scenarios have the advantage of providing degrees of confidence for the rates of carbon reduction achievable in client portfolios, if we took no action and portfolios stayed as they are, Tang explains. This helps ascertain what natural rate of carbon emissions decline clients should expect to see in their portfolios – and then what subsequent action is needed via proactive positioning and engagement by the asset manager to meet carbon reduction objectives.
“Through the intensity of our research, we are helping pension funds get a better understanding of the portfolio composition at the issuer and sector level as well as a good understanding of the thematic drivers, sectors, and emission contributors – which will help lead the way to get to net-zero.”
Given that clients are only at the start of the net-zero journey, longer-term engagement and stewardship of assets will also play a key role.
Engagement
“Engagement aligns to our firmwide policy on stewardship,” says Gorman. “We have thousands of equity led engagements per year across the firm, where progress is tracked and measured. Companies targeted will include those screened according to ESG and climate commitment criteria. The best and most effective time to engage with credit issuers is prior to issuance – and we can demonstrate considerable success in influencing issuer behaviour as well.”
In the medium to longer term, the group will continue to use advanced analytics processes and targeted engagement to support its clients’ commitments towards decarbonising portfolios.
Governments, investors, and pension savers are all exerting pressure on companies to commit to reducing carbon emissions to net zero through measures such as investing in renewable energy sources, cutting back on carbon-intensive business exposures, and participating in carbon offsetting activities.
The road to net-zero
The Paris climate conference (COP21) adopted the Paris Agreement in December 2015, understanding the importance of limiting global warming to 1.5˚C. To achieve this, global per annum net emissions need to be reduced by 23 gigatonnes of carbon dioxide by 2030 – approximately half of current levels.*
Those leading the pack have signed up to the United Nations-convened Net-Zero Asset Owner Alliance, which was set up to achieve net-zero emissions goals by 2050 in line with the Paris Climate Agreement.
More than 40 asset owners with $6.6trn in assets under management between them have signed up to the alliance, which requires them to commit to interim targets for decarbonisation. They are setting baseline emissions levels for their portfolios, and then committing to interim five-yearly targets.
In addition, under forthcoming rules introduced under the Pension Schemes Act 2021, UK pension funds will have to start disclosing the climate risks to their investment portfolios in line with the reporting recommendations of the Task Force on Climate-related Financial Disclosures.
*Source: Intergovernmental Panel on Climate Change’s Special Report on Global Warming of 1.5˚C; October 2018.
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snapshot
BlueBay Asset Management
For UK Professional Investors only
demand for investments to have a sustainable edge and positively impact the world has resulted in strategies which support investments in green, social and sustainable bonds.
nstitutional investors have long used fixed income markets to generate alpha and risk-adjusted returns, but more recently the
The team evaluates a combination of forecast carbon trajectories and active bottom-up issuer analysis to support client’s carbon reduction targets.
The Paris climate conference (COP21) adopted the Paris Agreement in December 2015, understood the importance of limiting global warming to 1.5˚C. To achieve this, global per annum net emissions need to be reduced by 23 gigatonnes of carbon dioxide by 2030 – approximately half of current levels.*
The data lake captures more than 300 million unique financial and non-financial data points for over ten thousand issuers
Learning the future path of
carbon
reduction in portfolios
Columbia Threadneedle Investments explains how it is helping clients understand the future path of carbon reduction in their portfolio through highly sophisticated data and analytics
Through its sophisticated ‘data lake’ – a vast repository of raw investment data – Columbia Threadneedle has made several observations through running forecast scenarios across client portfolios.
When deciding how to meet their sustainability objectives in their fixed income portfolios, asset owners need access to in-depth analysis of the future path of carbon reduction.
The data lake
The data lake captures more than 300 million unique financial and non-financial data points for over ten thousand issuers over more than the past decade, culminating in over 300 carbon relevant factors per issuer. It draws on various sources, including MSCI and the Carbon Disclosure Project, as well as bespoke providers that can provide physical asset locations of each company’s infrastructure and buildings, for example.
This analysis has resulted in a diverse set of projections across credit portfolios. Some forecasts for decarbonisation imply low levels of reductions, while some are much higher. The bottom-up carbon composition of an investment portfolio and its sectoral makeup both play a role in forecast reductions, says Tammie Tang, credit portfolio manager for institutional clients.
For example, for a European high-yield portfolio, analysis shows that the natural rate of carbon reduction to 2025 would only be 7%. In contrast, some sterling investment-grade portfolios have shown natural declines of 9% – and in some cases as high as 48%. Columbia Threadneedle's global investment grade portfolio had a forecast natural decline of about 25%.
Tang says her team has found that several factors can impact their carbon reduction forecasts.
Measuring future carbon trajectory
“If the portfolio has a lower carbon intensity to begin with than the
“In that case, the contribution to future reduction of these emitters is likely meaningful and therefore by not holding these, clients’ forward path of reduction is likely to be lower. In addition, portfolio composition at the sector level matters as well.”
This feeds into much of the underlying research that the group is building around the path of forward trends. For example, the UK utilities sector has been critical in driving past trends, particularly over the past decade, during which time it has reduced carbon emissions by 60%.
“If utilities account for around 15% of sterling index contribution, we can begin to see why numbers as high as 40% have been forecast for some funds,” Tang continues. Looking ahead, “The ongoing carbon reduction in sectors such as utilities as well as energy, transport and industrials will have a big influence.”
The global high-grade universe is approximately $14trn (£10trn) in size with 2000 issuers. However, just a small proportion of issuers contribute the bulk of the carbon intensity. For example, 10% of the Barclays Global Corporate Index (the top 202 issuers) contribute more than three quarters (78%) of the total carbon intensity of the index.*
This past year, the team worked with a major European tier one insurer, which is signatory to the Net-Zero Asset Owners Alliance. The group’s own carbon forecast analysis found that the carbon footprint of some specific investment grade portfolios could fall, according to a mean estimate, by around 40% to 50% in the medium term and without making any changes. Then, the team showed them how active positioning could supplement and accelerate that natural progression. The combination of scenario analysis and active bottom-up positioning gave the client confidence to set interim targets. In March 2021, the client announced an interim 25% reduction target of carbon by 2025 for their investment-grade credit portfolio. Tang says this approach can help other asset owners make their own interim net-zero targets. “As active managers of high-grade credit, Columbia Threadneedle can help clients improve their understanding and conviction towards net-zero targets, based on the analysis of the natural decline and the analysis of active bottom-up positioning,” she says. “If we do this sensibly, potentially there may also be opportunity to enhance return given an absence of carbon premium for some higher emitting, slower trajectory issuers.”
How Columbia Threadneedle helped one asset owner set interim net-zero targets
CASE STUDY
Columbia Threadneedle analysis shows that energy, materials, and utilities issuers in aggregate have reduced carbon emissions by more than 35% on average over the last five years relative to other sectors. These sectors have also seen the largest improvement in factors associated with higher levels of adaptability relative to any other sector over the last five years.
Longer term, Columbia Threadneedle is expecting many other analysis tools to emerge that can support investors on a path of progressive carbon reduction. This includes the capacity to model physical asset risk, as Tang explains: “We could capture every single building and infrastructure in the
Modelling physical risks
By understanding the future path of carbon reduction in portfolios through the group's highly sophisticated data and analysis processes, pension funds can get well on the road to meeting their decarbonisation and net-zero targets.
Utilise data lake and advanced analytics
Evaluating forward carbon trajectories in existing portfolio holdings
Extract carbon trajectory estimates with confidence bands
Supplement with in-depth thematic research to assess underlying historical and forward looking drivers
WHAT
HOW
benchmark, then there is a chance that the forecast may also be lower, and that hinges on the fact that the portfolio is most likely not holding the highest emitters,” she explains.
WHERE NEXT
portfolio, and then stress it for hazards like heat stress and flood risk, and we can have models that look at its transition risk. For example, what is the risk of it of not being able to transition to a low carbon pathway?”
*Source: Columbia Threadneedle, March 2021
Explore BlueBay’s unique approach to integrating ESG with My-Linh Ngo and Lucy Byrne
Anthony is a Senior Portfolio Manager within the Emerging Markets Team. Anthony joined BlueBay in March 2006 and his primary portfolio management responsibilities include the EM long-short credit strategy, the EM Unconstrained Bond Fund and the suite of EM Corporate long only funds. Prior to joining BlueBay, he held a management position at National Australia Bank. Anthony holds a Bachelor of Commerce degree from the University of Melbourne, a Graduate Diploma in Applied Finance and Investment from the Australian Securities and Investments Commission, and is a CFA charterholder.
Anthony Kettle, Partner, Senior Portfolio Manager
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The team is not siloed, we're all based in London, because the asset class is so interlinked now
Our data science approach is something that we see relatively few other sustainable investors do, as yet
Emerging market debt: Four main sub-asset classes
• USD-denominated sovereign debt • USD-denominated corporate debt • Local currency-denominated sovereign debt • Local-currency-denominated corporate debt
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Tom Moulds, Senior Portfolio Manager My-Linh Ngo, Head of ESG Investment
The BlueBay Impact-Aligned Bond Strategy
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Tom Moulds, Senior Portfolio Manager
Q&A
carbon reduction in portfolios
When deciding how to meet their sustainability objectives in their fixed income portfolios,
asset owners need access to in-depth analysis of the future path of carbon reduction.
Tang says her team has found that several factors can impact
their carbon reduction forecasts.
“If the portfolio has a lower carbon intensity to begin with than the benchmark, then there is a chance that the forecast may also be lower, and that hinges on the fact that the portfolio is most likely not holding the highest emitters,” she explains.
Longer term, Columbia Threadneedle is expecting many other analysis tools to
emerge that can support investors on a path of progressive carbon reduction. This includes the capacity to model physical asset risk, as Tang explains: “We could capture every single building and infrastructure in the portfolio, and then stress it for hazards like heat stress and flood risk, and we can have models that look at its transition risk. For example, what is the risk of it of not being able to transition to a low carbon pathway?”
