Ethical Performance
inside intelligence for responsible business


Investors move into ethical fixed income products

April 2008

Bonds that reflect social and environmental concerns are becoming more popular among institutional investors in Europe and several fixed income products are now available, says Mike Scott

Ethical investment has a solid history behind it now – the European SRI market exceeds €1trillion (£780billion, $1.5tn), according to the European Social Investment Forum. But until recently there have been few opportunities for ethical investments in bonds.

However, this is changing. Royal London, F&C, Standard Life Investments and Rathbone Greenbank are among those that offer ethical bond products – and Innovest Strategic Investors and JPMorgan last year launched the JPMorgan Environmental Index-Carbon Beta (JENI-Carbon Beta), the first bond index to address the risks of global warming.

According to Lipper FERI, the amount invested in SRI bonds in Europe as of the end of January 2008 was €5.8bn, up from €1.4bn in 2002.

In some ways, environmental, social and governance issues are more material for bonds than equities because of the longer time frame involved for fixed income products, says Rory Sullivan, head of investor responsibility at |nsight Investment. ‘Over a year or two, climate change issues are not going to have a massive effect on the equity of a utility, for example, but over 20 years or so, the likelihood of an impact increases whether it is from extreme weather events, a shortage of water for cooling, increased demand or whatever. The risks may be sufficiently large to lead to a credit default.’

One of the most prominent fixed income funds in the UK is F&C’s Ethical Bond Fund, launched in October 2007 and managed by Rebecca Seabrook. The fund operates the same exclusions as the company’s Stewardship funds, so it targets issuers that contribute to sustainable development by, for example, providing housing, water or renewable energy, as well as those with good business practices in the environment and human rights. The fund also operates traditional SRI exclusions in areas such as tobacco, alcohol, gambling, pornography and weapons – as well as companies with poor practices towards the environment, human rights or labour relations.

‘Investors should be able to make the same socially responsible investment decisions for their bond investments as with their equity portfolios’, says Seabrook. The fund has outperformed since its launch, mainly because it is underweight in financial stocks, she adds.

Bonds allow investors to diversify their portfolios and lower risk, but the default choice of government bonds is ethically questionable for some people.

Robert Barrington, director, governance & sustainable investment at F&C, says: ‘Governments are likely to be involved in activities that breach [our] fund’s ethical criteria, and this is the reason we exclude government bonds. For example, the fund has a strict policy of not investing in arms companies, but all governments are, to a greater or lesser extent, the customers of such companies as they maintain a military capability.’

However, sovereign bonds – as the most stable form of investment – are mainstays of many institutional portfolios, so exclusion is not always an option. Both Eiris and German research group oekom rank sovereign issuers on sustainability. The main purpose is to provide sustainability-oriented investors with a basis for investment decisions, says oekom. ‘However, our analyses do not merely reveal aspects which are important from the ethical point of view, but also point to economic and social risks,’ explains Oliver Ruedel, senior analyst.

In oekom’s most recent analysis, Norway, Sweden and Denmark top the rankings of the 50 countries studied because of their low unemployment rates, high spending on education and the relative lack of coal in their energy mix, matched by a strong commitment to renewable energies. Germany is in eighth place, ahead of the UK and France (12th and 15th respectively) partly because of its progressive climate policy and environment laws. The US lies in 36th place behind Brazil and Mexico, because of high defence spending, abduction and torture of terror suspects, the possession of nuclear weapons, continued use of the death penalty and its refusal to ratify treaties such as the Kyoto Protocol, says Ruedel.

Bonds open up opportunities not available to equity investors, says Mark Mansley, strategy and communications manager at Rathbone Greenbank Investments. These range from infrastructure-based investment products such as railway finance and social housing bonds through to microfinance funding and also unlisted businesses such as the Co-operative Bank, which issues bonds.

One problem often cited for SRI when it comes to bonds is that there are fewer opportunities for engagement. ‘The attitude is often – “you can’t vote so why bother”,’ says Sullivan. ‘We have the same discussions with companies whether we own debt or equity.’ Katja Karas of Danish fund Bankinvest, which runs an SRI global bond fund, agrees. ‘We actually get a better response on engagement with the fixed income funds,’ she says. ‘This may be because the fund is focused on emerging markets, where companies are issuing lots of debt as they grow, so for that reason they need to keep investors happy.’

SRI fixed-income products are set to grow, says Stephen Hine, head of international relations at Eiris, given the number of institutions signed up to initiatives such as the UN’s Principles for Responsible Investment. ‘If you are a financial services provider that is serious about sustainability criteria, you need a full suite of products to reflect that.’

European Social Investment Forum | Global | SRI

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