Sustainable investing is still investing

Governments around the world are increasingly focused on trying to build the regulatory frameworks around which a more sustainable future can be achieved. This legislation is affecting the fundamentals of companies and as a result is creating a whole new range of opportunities, as well as risks, for equity investors.

Sustainable investing is, however, still investing, so the same rules apply. In the excitement of how quickly everything is changing, some of those rules may have been forgotten, and already we see frothiness in some areas of the market. We only invest in companies after thorough research that incorporates detailed ESG analysis to understand the risks and opportunities coming from the evolving ESG landscape, as well as a disciplined view on valuation.

Ultimately, we want to invest in high quality, well managed companies that make money and return cash to shareholders. For this reason, we believe a lot of the value at the moment can be found in forward-thinking established companies that are embracing change, or that are investing in their businesses to stay relevant. That’s where the best risk-reward trade-off is likely to be found.

Green bond demand is surging

There’s no doubt that investor appetite for sustainable fixed income is strong and growing. In 2021, there was nearly $1 trillion issued across green, social, sustainable and sustainability-linked debt – double 2020 levels . In 2022, we think issuance could double again, presenting a wealth of opportunities for investors.

However, the dynamics of sustainable investing are a little different in the bond markets. From an equity perspective, companies with the best sustainability behaviour should be able to fund themselves at a lower rate. Basically, being able to demonstrate strong sustainability or ESG credentials to equity investors is increasingly seen as an indicator of good management. In fixed income markets, issuers with strong ESG characteristics are increasingly seen to present a lower credit risk, which translates into a lower coupon and lower yield for bond market participants.

Conversely, issuers that are ESG laggards are likely to be penalised with a higher cost of funding. One of the things we know about the bond market is that, over time, a higher yield leads to a higher return. Therefore, as we collectively focus on doing the right thing, fixed income investors looking to fund sustainability and green-linked issuance will have to be willing to accept slightly lower yields and a slightly lower return.

Nevertheless, there is a role that active fixed income managers can play in identifying those issuers who are on an improving ESG trajectory that may not be incorporated yet into market pricing. Similarly, if we view an issuer’s ESG framework as less credible than the market currently appreciates, we can identify those risks that may not be priced by those in the market that rely on a generic ESG score.

Forestry tops the sustainability agenda

When it comes to sustainable investing in the alternatives space, forestry as an asset allocation in real assets represents one of the most exciting opportunities at the current time.

Forestry allows sustainable investors to benefit from harvesting timber, which is a sustainable building material that’s grown around the world. Timber can generate a constant income stream, which is attractive in today’s low yield environment, while timber prices are also supported by strong demand for building materials, particularly in Europe, as shown by the recent growth in shipments from US forests. Furthermore, the land on which timber forests grow has value, and this value is appreciating based on inflation.

Investing in forestry also allows investors to buy an option on the value of carbon. Thanks to the role forestry plays in the global carbon offsetting market, investors can effectively monetise some of the carbon that their forestry investments remove from the atmosphere. We expect this amount to increase as the global economy transitions towards net zero. And, as we plant new forests, the carbon sequestered is going to hopefully have a real impact on the E part of ESG.