Beyond Profit: How effective sustainability measurement will take Asian bond portfolios to the next level

Despite its strong growth in the past year, the long-term success of sustainable bonds in Asia relies on greater disclosure and a clear, data-driven investment process to assess and measure the impact of proceeds, according to Angus Hui, head of Asian and emerging market credit, Asian fixed income at Schroders. In this Beyond Profit series, Schroders explores sustainability in various investment aspects.

Trends in bond issuance and investment behaviour over the past 12 months suggest sustainable fixed income is at a tipping point in Asia.

“Close to 20% of gross issuances in Asia so far this year have been in green, social, sustainable and sustainability-linked bonds, and now Asian issuers are the largest source of ESG bonds across emerging markets (EM),” Hui said.

Asian opportunities broadening from climate change to social

In Asia, the appetite for ESG-related bonds continues to be focused on addressing climate change. This overshadows social bonds until the outbreak of Covid-19 which heightened awareness of social issues like equality and poverty.

India is a major player in green bonds – renewable energy in particular – in part due to the country’s supply/demand imbalance, Hui said. Some Chinese property developers are active in green bond issuances in the high yield space. Together with renewable bonds, they account for the majority of high yield green bond market in Asia.

Although lagging green bonds to date in terms of issuance, social bonds are garnering more investor support as issuers increasingly reveal details of how proceeds will help achieve UN Sustainable Development Goals, such as supporting employees’ well-being or reducing poverty.

Hui said the key to capturing opportunities is to identify names with improving transparency and governance, as well as those with a thoughtful approach to managing their climate risks. “For example, as it will become harder for coal-mining companies to secure funding going forward, their credit risks will increase. In comparison, energy companies with a proper transition framework will be more competitive and attract investors’ interests,” he said.

Yet the ongoing appeal of these instruments will depend on whether they satisfy emerging demands for greater transparency, which is essential to assess individual securities and measure their real impact on sustainability.

Be mindful of limited correlation between green bond and corporate sustainability

Indeed, initiatives to close the information gap are gathering pace. Central banks and other regulatory authorities, for example, are placing more obligations on asset managers to consider the implications of their investments, plus to report ESG data. Further, the new EU Sustainable Finance Disclosure Regulation (SFDR) will create more detailed reporting requirements. This will helpfully reduce opportunities for ‘green washing’ since companies will find it more difficult to mask the extent of ESG activities within their overall business.

As investors, Hui highlighted the importance to evaluate the overall ESG quality of a company when looking at an investment. There is limited correlation between the issuance of a green bond and the overall sustainability of the company.

“Green bonds issued by Chinese developers, for example, are often issued with a project-specific purpose. So, for a company with a diverse portfolio of 100 properties, there will be little overall ESG impact if the proceeds are only intended to make a single building more resource efficient. This is why a thorough and holistic approach to conducting credit investment analysis plays an essential role in identifying opportunities,” Hui explained.

Hui added that investors must not overlook governance as a key factor in any investment decision. “While the ‘E’ and ‘S’ have become more topical, sidelining the ‘G’ is an oversight, given it plays a central feature in credit analysis, such as by helping determine the potential for ratings downgrade, or default probabilities. Companies with better governance tend to live up to their environmental and social responsibilities, too,” Hui said.

SustainEx: quantifying sustainability

This is easier said than done. Without knowing how a company manages changes relating to the environment and society, the impact of sustainability efforts cannot be measured and, therefore, the investment cannot be effectively managed.

Being able to articulate and isolate the environmental and social impacts of an investment to drive returns, however, requires the availability of comparable data that remains a challenge to source.

“As such Schroders created a proprietary tool called SustainEx that integrates ESG considerations and associated data in the investment process to make ‘sustainability’ measurable,” Hui said.

Schroders’ SustainEx measures the costs companies would face if all of their negative externalities were priced, or the boost they would receive if benefits were recognised financially.

“For example, SustainEx will be able to quantify and tell us a company’s “social value” as a percentage of revenue. If a company has a score of +5%, it means that for every $100 of sales the company is making, it is making an overall positive impact on society equivalent to $5,” Hui added.

Figure: Each positive and negative impact is quantified in financial terms

The SustainEx tool is aimed at helping analysts, fund managers and asset owners identify those risks, to help ensure they are reflected in investment decisions and valuations. To achieve this, SustainEx integrates data points from over 700 industry and academic studies on externalities and social impact, plus analysis of more than 16,000 companies.

“We are here to help investors understand the ESG data points for individual holdings, as well as the sustainability contribution from their investments. We want to help them effectively incorporate sustainability goals within their portfolios,” Hui said.

This article first appeared in the AsianInvestor on May 11, 2021.