Sustainable bonds – which focus on environmental and social issues – took the market by storm in 2020. In 2021, Moody’s Investors Service predicts the sector will grow by 32 per cent to $US650 billion ($850 billion) globally. That’s double the $US324 billion of two years ago and potentially 8-10 per cent of this year’s total global bond issuance.

The question is, why should you, as an investor, care?

The rise of for-purpose investors

 The fact is, says NAB Global Head of Sustainable Finance David Jenkins, more and more investors do care – and that’s been a large driver of the stellar growth in sustainable bonds over the past year.

“There’s been increasing numbers of [people] – whether institutional investors, millennials, mums and dads – all looking to invest with purpose,” Jenkins confirms. “That really accelerated over the last 12 months.”

Jenkins believes the pandemic clearly had an influence here – not just because of societal issues but environmental initiatives too. “People became painfully aware of the need to future-proof our systems against environmental and economic shocks,” he says.

The European Union’s latest environmental regulations also had a significant impact, further prompting investors to ask pointy questions around sustainability as a matter of course “One to two years ago, it was the last or second last question asked at an investment roadshow,” Jenkins says. “In 2020, it become the No.1 question: ‘What are you doing around sustainability? How are you addressing these new ESG-related risk factors in your business?’”

Defining sustainable

 If you’re considering entering this surging investment space, how can you be confident the asset you’re investing in is truly sustainable?

It’s hard not to be daunted by the array of products on offer. But look closer and there is some underlying order, and rigour – particularly in the fixed income market where external verification or certification supports the bonds on offer.

While sustainable investing is usually a catch-all phrase to cover environmental, social and governance (ESG) screening – and whether you should exclude (or include) a particular business or sector from your portfolio – when it comes to sustainable bonds, there are a few distinct products to look out for.

Green bonds (also known as climate bonds): Green bonds finance projects that make a specific, positive environmental impact. Australia saw its first deal in 2014, when NAB raised $300 million to finance a portfolio of renewable energy assets, including wind farms and solar energy facilities right across Australia. Green bonds get much of their legitimacy from the fact that they are typically certified under the Climate Bonds Standard or aligned with the ICMA Green Bond Principles – both international benchmarks. “In order to qualify for the Climate Bonds Standard certified label, they need to meet a prescriptive set of eligibility criteria, which is science-based and in line with the Paris 2050 agreement,” Jenkins explains. “If you were to find a certified green bond opportunity, you would first get  comfortable with the nature of the credits based on the credit assessment, but also rest assured that it would be contributing towards a lower carbon economy and delivering positive environmental outcomes.”

Social bonds: The proceeds from these bonds are to be exclusively applied to existing or new projects that promote positive social outcomes. This often means helping less privileged groups such as the unemployed, people with disabilities or other marginalised communities, including women. NAB, for example, raised money to help finance (or re-finance) organisations that were cited by the Workplace Gender Equality Agency as Employers of Choice for Gender Equality. More recently, several social bonds have aimed to address COVID-19-related issues, with a particular focus on those populations most heavily affected. They are governed by voluntary guidelines, known as the ICMA Social Bond Principles. “Like green bonds, they are supported by second party opinions,” Jenkins says. “[Furthermore,] these bonds come with annual impact reporting where investors can identify the impact that their dollars are contributing towards.”

Sustainability bonds: These are a mix of the above two bonds and are again governed by a set of principles known as the ICMA Sustainability Bond Guidelines. In 2017, NAB arranged the first sustainability bond in Australia for the Australian Catholic University. The proceeds helped fund some key social research programs focused on the most vulnerable people in society, as well as refinancing a number of green building projects.

Sustainability-linked bonds: Rather than financing a specific project, these loans or bonds are linked to the issuer meeting certain sustainability goals, with the borrower committing to meet certain sustainability-linked targets over the life of the bond or loan. For example, French luxury label Chanel raised €600m (A$944) through a sustainability-linked bond. The deal was linked to a set of environmental targets, including cutting emissions within the firm and its supply chain. “They’re a little bit more complex because they have bespoke sustainability metrics that relate to the borrower,” Jenkins says. “They require a bit more due diligence.” However, he is confident they are set to take off in Australia – as they have globally.

So, is it time to get involved?

 This will depend on your financial position and your investment goals.

Sustainable bonds represent an important defensive play – if not high returns just now. They also support a sustainable future. “These are a clear opportunity for investors to get access to a liquid form of investing that delivers externally verified positive environmental or social outcomes,” Jenkins says.

Moreover, there are a range of ways to access them. A growing number of exchanged traded funds (ETFs) track sustainable bonds, while last year saw the launch of Australia’s first managed fund of green bonds – investment manager Altius putting together a portfolio of about 30 corporate and government bonds committed to financing projects that aim to reduce carbon emissions.

Private wealth investors may also have the opportunity to buy into unlisted deals, as an ever-wider range of businesses and sectors look to tap the over-the-counter market. Nevertheless, you’ll need to qualify as a wholesale investor (with at least $2.5 million in net assets or $250,000+ in annual income), and you’ll want access to a bank’s fixed income desk. “If you don’t have access to a sub-institutional desk like we have at NAB or JBWere, you have to go to the open market through your advisers and purchase them that way, and typically expect to pay a premium for them given the strong demand,” Jenkins warns.

He is confident options will continue to open up for individual investors, however, as issuers increasingly seek to tap the market, particularly on the environmental side. “There’s a huge push towards de-carbonisation on the corporate side, so we expect to see a lot more borrowing from those companies looking to invest in energy efficiency, emerging technologies and the uptake of renewable energy. [I think it’s inevitable] that we’ll continue to see a rising spread in investment opportunities.”