The lion's share of attention in sustainable investing hasn't been directed towards instruments representing the most profound investment paradigm shift, one that promises to permanently alter the landscape of capital markets themselves. That is: the rise of sustainable bonds. Here we will explore what sustainable bonds are, why they matter and what you should consider before adding them to an investment portfolio.
What Are Sustainable Bonds? A simple yet effective definition of a sustainable bond is that it offers investors information about the issuer's proceeds through the bond issuance. SBs differ from their rapidly growing cousins, green bonds, in that they offer issuers a broader mandate of acceptable environmental, social, and governance uses for the proceeds of the bond, as opposed to the narrower environmental concerns of green bonds. In other words, within the scope of responsible investing, a green bond focuses solely on the "E" component while a sustainable bond incorporates both the "E" as well as attending to the "S" attributes of the company's operations and capital deployment.
Most attention regarding improved ESG and corporate social responsibility (CSR) considerations by corporate entities has been focused on equity shareholder interests and a company's associated enterprise value. This is particularly interesting considering that the debt markets have now become the principal source of external financing for U.S. firms, dwarfing equity issuances in recent years.
Since 2006, new corporate bond issuances have exceeded new issuances of equity more than eight-fold. This increase also translates to the number of such companies that use primary bond markets: from about 1,250 before the 2007 debt crisis to more than 2,500 today. One longer term trend of significance is that bond financing is less expensive than equity financing and is likely to remain so, at least in the foreseeable future.
As investor concerns with ESG gradually catch up with the most prolific investment instrument available to them (bonds), companies will increasingly need to reorient their offerings to satisfy these values. As these parties come into alignment and ESG becomes increasingly mainstream, we will witness perhaps the most significant change to capital markets in a generation. Investors and corporations alike should heed this development.
Why Do Sustainable Bonds Matter? Articulating the business case for SBs requires a brief examination of several factors covering multiple self-motivating interests of various groups. Ultimately, the greatest value of a dedicated sustainable or green bond is what management sometimes overtly communicates through the adage, "Put your money where your mouth is."
The intrinsic value of sustainable/green bonds is multi-fold. SBs prioritize the importance of issuers explicitly taking into consideration externalities, such as the environment and their environmental footprint, as a means of either reducing risks or forming a competitive advantage through improvement in efficiencies. They also help investors have a clearer understanding of management's priorities and business practices.
Here are a few examples of such considerations:
Intangible Value. As economic records have been broken with the ascent in the market's valuation, the underlying asset that truly garners this meteoric rise is the value that investors and consumers place on intangibles.
