Achieving Positive ESG Impact with Market Rate Fixed Income Investments
Every investment across every asset class has social and environmental impacts—positive and negative. That goes as much for investments that fail to take environmental, social or governance issues into consideration as to those that explicitly pursue sustainability, corporate responsibility, or positive social and environmental impact.
A well-diversified portfolio holds investments diversified across several asset classes, including (but not necessarily limited to) equity (stock), fixed income (bonds) and cash. Investments within each asset class are expected to behave similarly with respect to such economic variables as changing interest rates, rates of economic growth, and rates of inflation.Typically, a fixed income allocation is used in a portfolio to provide income and to reduce portfolio volatility, compared with an equity allocation.In times of recession, bonds offer greater security than equities because debtors (such as corporations and Federal, state or local governments) are obligated to pay interest and to repay debt before making any distributions to equity holders.During the 2008 market downturn, nearly every market-based investment declined – except U.S. Treasury bonds, as investors sought the assurance that they would get their investment returned at maturity.However, when interest rates rise significantly, bonds holdings can drop in value.
Investors can increase their positive Environmental, Social and Governance (ESG) impact with fixed income holding by re-allocating funds into municipal and corporate bonds or bond funds that finance projects with social or environmental impacts that align with their values.
For example, the World Bank has issued almost sixty green bonds since 2008, with an estimated total value of over $4 billion. A World Bank green bond has the same credit quality as any other World Bank bond, but the proceeds are specifically designated by the World Bank for climate-related projects. These bonds are triple-A rated, secured by the full faith and credit of the World Bank, and not linked to the performance of the projects, so investors do not take any project or country risk, according to the offering documents.
The World Bank Green bonds are “Use of Proceeds” bonds. While investors do not know in advance the specific projects that will be funded with their money, the Bank earmarks the funds for projects which address one or both of two categories: Climate mitigation and climate adaptation.
World Bank Green Bonds were among the first fixed-income investments to allow the investor to be confident that funding would be directed to carbon footprint reduction and improved energy efficiency. The bonds have provided debt financing for large-scale projects, including rapid transit systems in Colombia, China, Mexico and India as well as infrastructure projects in Jamaica, Turkey, and the Ukraine that reduce the energy consumed and associated greenhouse gas emissions in medium-sized and large industrial enterprises. Coal and nuclear power generation projects are explicitly excluded from consideration.
After the ground-breaking work of the World Bank, other supranational issuers have followed suit. For example, in the fall of 2013, the African Development Bank (AfDB) launched its inaugural Green Bond transaction. The $500 million offering was placed with three dozen investors, including Trillium Asset Management.
“This first Green Bond of the African Development Bank is part of its quest to use public-private partnerships to meet the challenges of development in Africa. It is another opportunity for private capital to earn market rates of return, while supporting sustainable and low-carbon growth in the continent,” says Donald Kaberuka, President, African Development Bank Group.
The proceeds of the AfDB Bond support the financing of low carbon and climate resilient projects in line with AfDB’s long term strategy which focuses on inclusive and green growth. Projects to be financed include those in renewable energy generation, energy efficiency, vehicle energy efficiency fleet retrofit or urban transport modal change, biosphere conversation projects, solid waste management, fugitive emissions and carbon capture, urban development, and water supply and access.
The Green Bond market is developing rapidly. Additional issuers during 2013 include the Commonwealth of Massachusetts, the first municipality to issue a Green Bond, and Bank of America, which inaugurated a corporate Green Bond issue in November.
Trillium clients have also invested fixed income assets with Community Capital Management (CCM), which specializes in managing impact investments. CCM’s CRA Qualified Investment Fund Retail Shares (Ticker: CRATX) were created for individual investors and their advisors interested in the Fund’s impact investing strategy, which had been designed to meet the Community Reinvestment Act funding requirements for banks. In this share class, individual investors have the opportunity to invest in a mutual fund that proactively screens for investments that support community development such as affordable housing, job creation, small business development, and environmentally sustainable initiatives.
Another interesting concept under development is the social impact bond. This new financing model is under development, with the goal of accelerating social innovation and improving government performance by combining performance-based payments and market discipline. Advocates for the approach believe it has the potential to improve results, overcome barriers to social innovation, and encourage investment in cost-saving preventive services.
Under the social impact bond model, a government contracts with a private-sector financing intermediary to obtain social services. The contract specifies explicit performance targets. The bond issuer acquires capital by issuing bonds to private investors in exchange for a share of government payments that become available if the performance targets are met.  The bond issuer uses these operating funds to contract with service providers to deliver the services necessary to meet the performance targets.
The government payments to the intermediary are contingent upon achieving performance targets. If the outlined social outcome isn’t met by the agreed upon date—while also meeting the monetary performance target, the government pays nothing back to investors.
For example, the Massachusetts Juvenile Justice Social Innovation Financing Project has recently launched a 5 year pilot program that is focused on reducing incarceration rates among high-risk young men that were formerly involved in the justice system. The project’s goal is a 45% reduction in incarcerations (248 incarcerations / 224,205 days of incarceration) among the targeted population, resulting in better social and fiscal outcomes while also generating long-term cost savings for the state.
If the project achieves its goal, then the government pays investors back with a financial return. And, of course, the potential monetary reward is in addition to the positive social impact.
The tools and impact investment options may be different in each asset class, and those available for fixed income investors are less well known than the options for either public or private equity investors. However, there is no question that there are opportunities to leverage all aspects of a portfolio for positive impact.
Editor’s Note: This article appeared in the Winter 2014 issue of Trillium’s newsletter, Investing For a Better World.