Tag: Food & Farming

Above Infographic excerpt, shown below – HIP Climate Threat Resilience Ratings of US Counties

When sailing your portfolio into the future, would you want a top-heavy boat? Or a boat that is stable through the waves of future risks? “Green bonds,” “social bonds” and “sustainability bonds” – these labels bring comfort to impact investors. Yet, are all green, social and sustainability bonds fully safe for the forthcoming 30 years?

Our HIP Investor Ratings of 270,000 bonds – whether issued by more than 100,000 municipalities, 14,000 corporates, or 200 sovereigns – evaluate the possible future risks and future opportunities of the underlying issuers and use of proceeds.

As of August 30, 2024, HIP has evaluated 11,487 bonds that are labeled “green,” “social” or “sustainability-linked,” which seek to bring solutions like reducing pollution, delivering cleaner water, spurring more affordable housing, or bringing climate action forward to society as well as to your portfolio.

These positive impacts can build a better world and could bring more stable income and a higher-confidence of principal repayments in the future. Yet they also need to be evaluated for climate risk and resilience.

What are Green, Social and Sustainable Bonds Funding?

What are the key uses of proceeds in green, social and sustainable labeled bonds?

Of the 6,058 green bonds we have evaluated, more than a third of bond proceeds mention a (37.5%) focus on water quality improvements, while a tenth of them (10.9%) target effective treatment of wastewater; overall, about half of Green Bonds are issued by Water and Wastewater Utilities.

Additionally, energy solutions (5.3%) and pollution reduction (5.8%) are the focus of green bonds. Top issuers of Green Bonds are: Transportation District of New York and New Jersey (415 bonds), and state water bonds from New York state (313), Indiana (259), Iowa (193) and Massachusetts (175); yet also include educational institutions, energy utilities, and healthcare entities.

Of the 3,512 social bonds HIP has evaluated, more than a third of bond proceeds (34.2%) target housing, including affordability (25.5%), single family properties (13.7%), moderate-income families (12.7%), and can be linked to Ginnie Mae (GNMA, 4.5%). Overall, 88% of Social Bonds are from Housing authorities, while Education issuers cover about 7% of issuances. Top state-housing authorities of social bonds include: Illinois (226 bonds), Ohio (184), Massachusetts (172), Pennsylvania (163) and Rhode Island (160).

Of the 1,917 sustainability-linked bonds, just as the 17 UN Sustainable Development Goals are wide-ranging, so are these issuances. One-fifth (20.7%) focus on multi-family housing solutions, and one-sixth mention “rehabilitation” (16.6%). Efficiency in energy or water is a tenth of these (9.9%), and LEED-standards are present in 7.8% of these bonds. Poverty reduction (3.9%) and tenant-occupied housing (3.1%) seek to cover renters not just home-owners. Top issuers of sustainable-linked bonds include: New York City housing (778), New York State housing (352), and Massachusetts housing (212).

The average impact of green, social, and sustainability bonds are generally “net positive” (over 50 on a 100-point scale of sustainable to extractive). Impact investors typically want to hold higher-impact bonds in their portfolios.

Climate Risks Persist, Possibly Offset with Resilience

In the USA’s 3,100 counties, more than 40 years of FEMA’s (Federal Emergency Management Administration) recovery funding from intense and extreme weather events illuminate the risks across geographic regions of the United States.

Four main categories of weather – cold, heat, water, wind – summarize a range of events that can overwhelm buildings, roads, and infrastructure of energy and water.

In addition, facilities in each geography may add risks – nuclear power plants, toxic waste sites, waste dumps – which can negatively impact the ecosystem, from polluting drinking water from coal ash ponds that are flooded to a nuclear meltdown from a river overflowing.

These risks can be mitigated by resilience factors. For example, forests can absorb winds and rain more than farmland which can carry excess nitrogen fertilizer into waterways. Also, stronger community relationships can help regions recover when under stress. Of course, government policy and planning, including climate actions and defensive posturing, enhance the resilience of a region. Whether 3,100 counties, 84,000 census tracts, or 8 million census blocks, these future risks and resilience factors can be evaluated to specific GPS coordinates.

In the US map of 3,100 counties, the more red-colored areas are subject to more intense climate events and riskier physical sites that amplify the ripple effects of climate events, like hurricanes, tornadoes, ice storms, and heat waves.

Yet the bluer-colored areas are not immune to intense weather (e.g., El Nino storms in the Pacific, or the “perfect storms” of the Atlantic coast), the resilience in the Northern states and counties benefit from more forest areas, more community organizing, and more proactive government policy and climate-action plans.

Hence, for any corporate bond, municipal bond, or sovereign bond, a “climate threat resilience” rating as we call it at HIP Investor can be applied to your fixed-income portfolio holdings.

Credit Ratings Seem to Ignore Higher Climate Risk

Our analysis of 270,000 bonds from 3,860 issuers shows that Credit Ratings (such as Moody’s) may not incorporate the full set of meaningful future risks over the duration of the bond.

The scatterplot below charts the actual near-zero correlation (0.02%) among Moody’s Credit Ratings and HIP’s Climate Threat Resilience Ratings. This means a AAA bond from Texas, Florida, or Puerto Rico may not fully factor in the next three decades of hurricanes, floods, or winds – nor the lack of resilience in those geographies.

In fact, there may be opportunities to arbitrage these future risks. For most investors, avoiding these risks could be a prudent strategy – just as muni-bond ETFs do, such as the VanEck HIP Sustainable Muni ETF (ticker: SMI). In the SMI ETF, as of August 30, 2024, there are no holdings in Florida or Texas, due to higher climate risk and lower climate resilience, despite an elevated bond rating from Moody’s.

Are Green, Social and Sustainability Bonds also Climate Resilient?

While the bond proceeds for those labeled Green, Social, and Sustainable typically fund positive-impact projects, programs, and infrastructure, investors need to be aware of the climate risks too.

As you can see in the chart below, plotting 291 issuers of the 11,400 bonds, some of the issuers are in riskier geographies, such as Louisiana, the Florida Housing Agency and Harris County’s (including Houston) water utility.

The super-majority of green, social, and sustainable bonds evaluated by HIP have a “higher-impact” rating (above 50 on a 100-point scale) based on the data-driven performance, including schools, hospitals, energy and water utilities, and local governments.

Yet even the “green” or “sustainable” or “social” purposes of the bond may be at risk from future intense climate events, or lack of resilience defenses.

How to Optimize Risk and Return in Your Bond Portfolios

Bonds of corporates, munis and sovereigns are intended to be the ballast in your portfolio, just as a ship needs a strong hull and rudder. To evaluate these future risks requires analyzing the effectiveness of achieving the issuer’s mission, the actual benefits of the planned proceeds, and the potential surprises like climate in the coming years.

As we have shown above, the traditional credit ratings may not evaluate the full future risks of a 30-year bond. Our experience at HIP has shown that many lower-income communities can have highly effective hospitals saving patients, above-average school outcomes for kids, and cleaner water and energy for communities. This is not always consistent with the traditional belief that higher tax revenues collected in higher-income areas automatically generate better outcomes – it is a matter of competence to deliver its mission.

Evaluating future risk can be accomplished with data-driven factors: achieving its mission, specific results from use of proceeds, and optimizing risk and resilience from future climate intensities.

Impactful investors keep an open mind about the full spectrum of risks, and of opportunities. Your bond holdings can anchor a higher-impact portfolio that can both “do good” and “make money” in the coming decades.

Article by R. Paul Herman, founder and the managing member of HIP Investor Ratings LLC and Liana Lan, Climate and Impact Investing Analyst at HIP Investor Ratings LLC.

DISCLOSURES:

HIP Investor Inc. is a state-registered investment adviser in several jurisdictions (CA, IL, LA, NC, NY), and HIP Investor Ratings LLC is an impact-ratings firm evaluating impact and ESG on 410,000 investment ratings, including 126,000 municipal entities, 270,000 muni-bond issuances, and 14,000 corporates for equities and bonds. HIP Impact Ratings are for your information and education – and are not intended to be investment recommendations. Past performance is not indicative of future results. All investments are risky and could lose value. Please consult your investment professionals to evaluate if any investment is appropriate for you, your goals, and your risk-return-impact profile.  This is not an offering of securities.

HIP Investor, Inc. (“HIP”) is a provider to Van Eck Associates Corporation (“Van Eck”) of proprietary research products and services, including ESG ratings, Sustainable Development Goal ratings, Opportunity Zone mapping, Climate-Threat and Resilience ratings, and Human Impact + Profit ratings (collectively, the “HIP Ratings”). HIP is the exclusive provider to Van Eck of HIP ratings and similar data used in connection with any sustainable municipal-bond ETF provided by Van Eck, including the VanEck HIP Sustainable Muni ETF.

HIP Investor, Inc. (“HIP”) receives certain fees related to the assets under management (AUM) of the VanEck HIP Sustainable Muni ETF, which creates a conflict of interest with actual and prospective clients of HIP, and biases the objectivity of HIP when discussing, evaluating, and recommending the VanEck HIP Sustainable Muni ETF to actual or prospective clients of HIP. The determination to purchase or utilize the VanEck HIP Sustainable Muni ETF is an important decision and should not be based solely upon HIP’s recommendation, guidance, or services. HIP is an independent contractor of Van Eck Associates Corporation; however, HIP does not control or supervise the services or products of Van Eck Associates Corporation, and reference to the VanEck HIP Sustainable Muni ETF does not mean that HIP has performed any level of due diligence on the services or products of Van Eck Associates Corporation. Users of HIP’s website, as well as actual and prospective clients of HIP, are urged to perform their own due diligence on, or consult with a separate registered investment adviser with respect to, the VanEck HIP Sustainable Muni ETF. 

There is no obligation to purchase or utilize the VanEck HIP Sustainable Muni ETF.

In this Q&A, Ross Pamphilon and Mark Duffy of Impax Asset Management explore the nuances of the asset class of Impact Bonds and how rigor and expertise can help investors navigate an expanding opportunity set. 

Executive Summary

• We believe it is worth taking a nuanced view of impact bonds, considering both non-labelled and labelled green, social and sustainability bonds.
• Thorough issuer-specific research helps us to understand the environmental and social merits of each bond, assess the impact of financed projects, and maintain flexibility in labelling sustainable securitizations.
• Within a portfolio, impact bonds can offer stability, transparency, and diversification alongside attractive risk-adjusted returns.

Introduction

Over the last 25 years of investing in impact bonds, we have learned the value of looking beyond labeled green, social and sustainability (GSS) bonds.

By broadening the definition of impact bonds, investors can access a wider range of opportunities to generate positive environmental and social outcomes while pursuing attractive risk-adjusted returns. However, navigating this market requires a nuanced understanding of innovative security structures, evolving standards and project-level impact assessment.

Here, we look at how to define the asset class and explain why we look ‘off-label’, how the global impact bond market has grown, whether impact bonds involve higher credit risks, and the role these instruments can play in an investment portfolio.

1. How are Impact Bonds Defined?

The bond market generally defines impact bonds as labelled GSS bonds that finance projects with positive environmental or social outcomes (or both). These labelled bonds adhere to recognized principles like the Green Bond Principles and offer investors the extra assurances of use of proceeds reporting and third-party verification.¹

We take a more nuanced view and define impact bonds as use-of-proceeds and general-purpose bonds that raise capital for projects or activities with positive impacts, either environmental, social or both. We consider a breadth of securities – including asset-backed securities (ABS) and mortgage-backed securities (MBS) – issued by companies, supranational bodies and government-backed entities like local municipalities and state-owned entities.

Some of these investments have obvious positive environmental and social outcomes; others require a deeper dive to understand the impact.² Importantly, we consider both labeled and non-labelled bonds across fixed income sectors and activities. Our perspective is rooted in the search for additionality: unlike investments in equities, which are inherently tied to general corporate activities, bond proceeds can be directed towards a pre-defined use and so contribute to a targeted non-financial impact.

2. Why Should Investors Look ‘Off Label’?

We believe companies that take steps to adapt to and mitigate environmental and social risks have the potential to outperform over time, and we have developed our process to avoid overlooking this potential in non-labelled impact bonds.

Non-labelled corporate impact bonds often provide investors with the opportunity to invest in longer-dated maturities (more than 10 years) and larger deal sizes (more than US$750mn) compared to their labelled counterparts. Labelled bonds often have tenors of six to eight years as the maturity is intended to align with the project life. Longer duration allows investors to potentially realize greater returns if the credit thesis plays out as intended.

To effectively evaluate and select non-labelled impact bonds, we employ a multi-faceted approach:

• Thorough issuer-specific research to understand the environmental and social merits of each bond
• Assessing the impact of financed projects
• Maintaining flexibility in labeling sustainable securitizations

We have identified and categorized these bonds based on sustainability-related focus areas, illustrated below.

We include below three examples of non-labelled issuances that we believe deliver impact.

Corporate Debt: Xylem is a market leader in sustainable water management and net-zero goals, with a strong market position addressing global water challenges. The US company finances green projects that improve water accessibility, affordability, and resiliency through bonds like its US$1.9mn 2028 bond for improving water access, affordability, and resilience. We evaluate measurable impacts like water efficiency and conservation, quality and treatment, and climate resilience enabled by Xylem’s solutions. Xylem provides annual impact reporting aligned with Green Bond Principles, allowing investors to quantify its outcomes achieved. The company reports that its issuance of green bonds has resulted in 2.9mn megaliters of water saved or treated for reuse annually.³

Read about Impax’s approach to green bonds here.

First Help Financial provides securitization of auto loans made to Latin American immigrants in the US with limited financial history, promoting financial inclusion in underserved communities. To better verify customers’ ability to pay, the company accepts alternate forms of identity and income verification, and the entire underwriting and servicing team is bilingual. The company reported that it’s 2022 US$150mn issuance supported over 4,800 borrowers with limited English proficiency, almost 1,500 borrowers who were self-employed and financed over 1,600 work trucks or vans. Impax has invested in the 2024 round, sized at $US345.6mn.

Learn more about Impax’s approach to asset-backed securities (ABS)  here.

Supranational debt: Women’s Livelihood Bond – issued by Impact Investment Exchange, the Women’s Livelihood Bond (WLB) mobilizes private capital to invest in high-impact enterprises that aim to empower women. The WLB has raised US$228mn through six debt offerings, two of which are considered aligned with the Orange Bond Principles, focusing on gender-positive capital, gender-lens capacity and transparency. The WLB series reports that it has provided 180,472 female entrepreneurs in India, Cambodia, Indonesia, Kenya, and Vietnam with credit access.

Read more about Impax’s collaboration with supranational bodies in support of women and girls here.

3. Is Impact Bond Issuance on the Rise?

The impact bond investment universe has expanded significantly in recent years, creating a broader opportunity set for investors.

The chart below illustrates the increasing issuance of labelled impact bonds over the past decade. Total issuance topped US$1tn in 2021, though it dipped below this threshold in 2022 and 2023 as a result of factors like investor concerns around greenwashing.⁴ Issuance of non-labelled impact bonds has also grown over the past decade, but measuring that market is more nuanced.

Looking ahead, we see several key trends pointing to renewed growth in the labelled impact bond market, including the emergence of transition bonds and securitized products, a gradual shift in issuance activities from Europe to the Asia-Pacific region in response to investor demand, and large-scale policy initiatives like the US Inflation Reduction Act (IRA).⁵

4. Do Impact Bonds Involve Higher Credit Risk?

A common misconception is that investors must pay significantly more for impact bonds compared to conventional securities or accept greater risks for equivalent returns. Our experience (and industry research and analysis) suggests that such views are misplaced.⁶

The credit risk for corporate impact bonds is typically the same as conventional bonds, as the coupon and principal are legally deemed general obligations of the issuing entity. This is why our due diligence process looks beyond single bond issuances to incorporate a holistic view of corporate issuers.

We have observed that disclosure, a crucial window into credit risk, varies widely among fixed income sectors. Public corporate issuers generally provide the most comprehensive disclosure and government and private corporate issuers provide the least. A thorough analysis of both material quantitative and qualitative factors, including sustainability factors, is necessary to assess fundamental credit risk.

5. What Role Can Impact Bonds Play in a Portfolio?

Impact bonds can primarily offer three diverse qualities within portfolio allocation.

First, stability: the buy-and-hold nature of many sustainability-focused investors can lead to lower price volatility as these bonds often trade less frequently than conventional securities. Investors that engage in relatively small transactions can remain nimble, however; our team leverages specialized sell-side relationships that allow us to break up larger trades into more digestible sizes and provide sufficient liquidity.

Second, transparency: regular impact and allocation reporting adds a layer of transparency and insight into issuances.

Third, diversification: investors with the resources and expertise to identify investments aligned with sustainability themes can go beyond standard business practices, employing a flexible, multi-pronged approach that identifies a broad range of opportunities.

A Growing and Impactful Opportunity Set

To navigate this expanding but complex market, we believe a nuanced understanding of innovative security structures, evolving standards and project-level impact assessment is key.

As the impact bond market continues to expand and evolve, we believe that investors who allocate resources and expertise to this area will be well-positioned to generate both carefully considered impact and risk-adjusted returns.

Article by Ross Pamphilon and Mark Duffy, CFA^® of Impax Asset Management

Ross Pamphilon is based in London and leads the global fixed income team overseeing the fixed income investment process including credit research and idea generation together with portfolio management. He is also responsible for the strategic development of Impax’s fixed income platform to provide a range of global credit solutions that are fully aligned with the transition to a sustainable economy.

Prior to joining Impax, Ross spent over a decade at Wells Fargo Asset Management, where as Head of Fixed Income EMEA he led the Global Fixed Income and European Credit teams. Previously, he was a co-founder of European Credit Management (“ECM”), where he built a career as a portfolio manager and held the positions of Head of Portfolio Management, Head of Investments and Chief Investment Officer, with responsibility for portfolio management, credit research and investment strategy. Prior to ECM, Ross was an emerging markets debt trader at Merrill Lynch in London, and also based in New York. He is a Chartered Accountant, having qualified with PwC.

Mark Duffy, CFA^® is a Fixed Income Analyst on the US Investment Grade Fixed Income team at Impax Asset Management. He is responsible for covering the consumer goods and diversified manufacturing sectors.

Mark has over seven years of experience in buy-side investment research across Investment Grade, High Yield and ESG. Prior to joining Impax in 2023, Mark was a Senior ESG Analyst at Invesco, a Corporate Credit Analyst at Longfellow Investment Management and a Senior Associate at State Street. Mark holds a bachelor’s degree in economics from the University of Connecticut and a master’s in finance from Bentley University. He is both a CFA® charter holder and an FSA credential holder, as well as an active member of CFA Society Boston.

Footnotes:

[1]  International Capital Markets Association, 2022: European Green Bond Principles

[2]  In our 2023 Impact Report, we reported that 39% of the issuers in one of our fixed income strategies reported GHG emissions avoidance data, and we were able to estimate GHG emissions avoidance data for about 25% of the portfolio. The remaining 36% of issuers in the portfolio either did not report data, or we were not able to make an estimate.

[3]  Xylem, 2023

[4]  Labelled impact bonds shown are those with third-party assurances as reported to Bloomberg. The assured impact bond data follows industry standard and is most widely cited across institutions. For our broader Impax universe, we also consider bonds that are not assured, preferring to judge each bond’s impact via our own framework. S&P Global, February 2024: US Muni Sustainable Bonds

[5]  The White House, January 2023: Building a Clean Energy Economy

[6]  Karoui, L., Lynam, A. et al, February 2022: ESG in credit: A costless benefit to portfolios (Puempel), Goldman Sachs