The Point

Take care when investing in sustainability-linked bonds

More companies are issuing “sustainability-linked bonds” — debt securities that pay a coupon linked to environmental or social outcomes.

These bonds typically don’t fund a specific project — instead they set overarching goals such as reducing emissions or improving corporate diversity.

If an issuer fails to hit its goal, usually it pays a penalty in the form of a higher coupon.

Sustainability-linked bond issuance hit US$103 billion globally last year — a yearly increase of 803 per cent, according to World Bank research.

But investors should take care that issuers are genuinely making changes and not simply greenwashing, says Pendal Credit ESG analyst Murray Ackman.

“In theory, they are great — but we’re starting to see some things we are not happy about with these structures.”

How green hydrogen will impact natural gas investors

The renewable energy transition is increasing the risk of “stranded assets” – such as fossil fuel infrastructure that no longer has an economic use due to redundant technology or high costs.

Green hydrogen is often touted as a potential solution for stranded asset risk in the natural gas industry. Is it really an answer?

“There’s this moon shot that green hydrogen will be a one-for-one replacement for gas,” says Pendal credit ESG analyst Murray Ackman.

The idea is some natural gas pipeline and storage infrastructure could be repurposed for hydrogen.

Hydrogen can even be blended into natural gas – but above 10 or 20 per cent it can damage existing pipes and household appliances would need to be updated.

ESG: What Albo’s 43pc emissions target means for investors

Energy security and workplace relations were among the biggest ESG themes in the recent ASX reporting season, says Pendal’s Rajinder Singh.

On the labour front, Rajinder says investors should take a look at a company’s agreements with workers.

“If you’ve got an agreement that’s due for renegotiation in the next 12 months versus one that was signed for five years, that could have a material impact on your forecast growth of your labour costs.”

For energy, security of supply is critical, says Rajinder.

“The other thing that matters for investors is understanding the capital expenditure required to address these issues.

“What’s the capital allocation to these initiatives? And is there an actual measurable benefit for the amount they are planning to spend?”

ESG: Fixed interest investors can make the world better too

Sustainable investors should expect fixed interest managers to engage with bond issuers, just as equity managers do with companies, says Pendal credit ESG analyst Murray Ackman.

Engagement refers to dialogue between investors and investees that seeks to improve policies or public disclosure on social, environmental and governance matters.

But it’s not just for equity investors.

Since large parts of the market are unlisted, fixed interest investors are discovering they have a critical role driving change at some of the world’s most important companies.

“Look at the biggest players in the climate transition — most of the utilities, many of the infrastructure owners — they are not listed entities,” says Murray.

“But they issue debt — so we have access to influence them.”

Pendal’s Income and Fixed Interest team has undertaken 73 engagements so far this year.

ESG: Beware the ‘brownium’ penalty

With high energy prices and oil and gas company revenues soaring, shouldn’t the big fossil fuel companies be outperforming in credit and equity markets?

In a pre-ESG world the answer would be ‘yes’.

But now big fossil fuel-based companies are paying a ‘brownium’ penalty to raise money in fixed interest markets — and are trading on lower earnings multiples in equity markets compared to previous years, says Pendal ESG credit analyst Murray Ackman.

“Bond people don’t tend to like taking as much risk,” says Murray. “And bond investors look at the downside risk of ESG as pretty significant.

“In the bond world, an investor could feel uncomfortable buying some energy bonds and holding them til maturity because the world in seven years or so will be very different.

“What if there’s a sudden policy change that no one saw coming?

“Pricing can be severely affected, and you don’t want to get stuck with a bond that you don’t want until maturity.”

Russia ‘self-sanctions’ are a coming of age for ESG

“Self-sanctioning” of Russia by brands such as McDonalds and Apple shows ESG is now a fundamental aspect of investing says Pendal ESG credit analyst Murray Ackman.

The voluntary sanctions demonstrate that society expects business to step up and take its environmental, social and governance obligations seriously, says Murray.

“Going forward, it’s going to be a lot harder for companies to pick and choose their ESG concerns.

“What’s interesting about Russia is that everyone is being called to account – by their investors, by their customers and by society – and asked to explain their exposure to anything Russian-related.

“This represents a normalisation of ESG.”

Taking an ESG approach to investing will help investors avoid this kind of risk in the future, says Murray.

“How do you predict an invasion? Can you forecast when a war will happen? An ESG approach to investing is basically the only alternative.”

What if zero-Covid fails in China?

Markets haven’t priced in the possibility of a large, uncontrolled Covid outbreak in mainland China, warns Pendal senior credit analyst Terry Yuan.

China is one of the few places pursuing a Covid-zero policy for reasons including vulnerability and political stability argues Terry.

If it suffers a big outbreak, China’s reaction would likely be swift and heavy handed, causing widespread impact on investors including:

– Limited immigration and associated capital flows into Australia and the rest of the world, putting upward pressure on wages, inflation and interest rates

– Delayed bounce-back among Australian travel and immigration companies

– Lockdowns, quarantines and hospitalisations creating bottlenecks in Chinese shipping and production

– Stimulus via fiscal and monetary easing putting pressure on Chinese interest rates

“We’re carefully selecting exposures to companies that have less exposure to China’s zero-Covid policy, but have strong earnings stability, balance sheet strength and sustainability credentials,” says Terry.