Investing in clearly defined projects with environmental or social impact

Impact Bonds: a promising new investment category

Strategy insights

Impact bonds are a relatively new and rapidly growing branch on the tree of impact investments. They offer investors the opportunity to invest in clearly defined projects with environmental or social impact, such as energy efficiency, green buildings and social housing. Fund manager Raymond Hiltrop explains the role of impact bonds in the portfolio of Triodos Multi Impact Fund.

“It is a rather unique fund”, says Fund Manager Raymond Hiltrop about ‘his’ Triodos Multi Impact Fund. The broad range of underlying Triodos funds makes Triodos Multi Impact Fund the flag ship of our investment funds. The fund invests globally in sectors that are crucial in the transition into a more sustainable economy. From sustainable trade and microfinance in emerging economies to renewable energy, arts and culture, and European pioneers in organic food and sustainable consumer products.

Triodos Multi Impact Fund is a fund-of-funds that invests for about 70% in eight Triodos impact funds and for about 30% impact bonds. Raymond Hiltrop: “Triodos Multi Impact Fund offers private investors the unique opportunity to invest in a promising new bond category, that until recently was predominantly accessible to institutional investors only.”

New and promising

Impact bonds are a relatively new and rapidly growing branch on the tree of impact investments. They offer investors the opportunity to invest in clearly defined projects with environmental or social impact, such as energy efficiency, green buildings and social housing. Triodos Investment Management considers impact bonds a valuable addition to the existing range of impact investments.

Raymond Hiltrop, Fund Manager Triodos Multi Impact Fund

Impact bonds are a fixed income instrument, the proceeds of which the issuer will use to finance clearly defined projects with environmental or social benefits. Their origins lie in the growing awareness of the need to counter climate change and preserve the environment. Projects initially focused mainly on the environment for example on renewable energy, energy efficiency, water conservation, green buildings and sustainable land use. Hence their name: green bonds. Over the last few years, however, the scope of green bonds has widened to include social projects as well, making the name impact bonds more appropriate.

Growing market

Since 2007, when the first impact bond was issued by the European Investment Bank, the impact bond market has grown rapidly, from a little over USD 1 billion in 2011 to USD 42 billion in 2015, whereas the total volume in impact bonds amounted to USD 90 billion by the end of 2015.

A strong catalyst behind these developments was the establishment in 2014 of the Green Bond Principles, a set of guidelines agreed upon by over 20 global investment banks. The total volume of impact bonds is expected to grow significantly in the coming years, fueled amongst others by agreements such as COP21.

Prominent in portfolio

Triodos Multi Impact Fund is one of the few Dutch funds to offer private investors the opportunity to invest in impact bonds. Hiltrop explains: “Impact bonds play an important role in the fund’s portfolio. First of all, obviously, for the impact these bonds are targeted to have. Because of their daily liquidity, moreover, they are an attractive addition to the portfolio of Triodos Multi Impact Fund from a pure investment perspective. Last but not least, they contribute to the moderate risk profile of the fund.”

Careful selection

Based on strict criteria Triodos Research screens the impact bonds for the portfolio. Hiltrop: "Through careful screening based on our strict minimum standards, we make sure that the bonds’ impact goals align with our own. In addition, as primary investor we have the opportunity to engage with the issuer on general or specific sustainability issues. Corporate engagement is an important pillar under our socially responsible investment strategy.”

Impact, liquidity and issuer quality are Triodos’ main selection criteria for impact bonds. The bonds selected for Triodos Multi Impact Fund’s portfolio are investment grade (ranging from triple ‘A’ to triple ‘B’), issued by supra-nationals, development banks, (semi) governments and financial institutions.

To ensure their tradability, the bonds must have a minimum size of EUR 500 million and to avoid currency risk only euro-denominated bonds are selected. “As fund manager I make the ultimate choice for an impact bond to be included in Triodos Multi Impact Fund’s portfolio”, says Hiltrop. “I select bonds using the same technical criteria as any bond fund manager, such as for example duration, risk and return and yield curve. In the current circumstances, the fund strives for an average duration of below five, given that the room for a rise is greater than the room for a drop in interest rates. Thus we try to limit the effect of a rise in rates on the price of the fund.”

Selected and rejected

The portfolio currently includes six impact bonds from four different issuers. “Telling examples are the bonds of the Nederlandse Waterschaps Bank (Bank of the Dutch Water Management Boards) and the European Investment Bank. The first gives a good picture of the thinking about and management of water in the Netherlands, while the second is issued specifically to finance the climate goals of the European Union.”

The strict criteria preclude that every impact bond qualifies for Triodos Multi Impact Fund’s portfolio. Hilltrop: “An example is the bond issued by Electricité de France (EDF). This bond was a huge success, being oversubscribed twice. Even if we subscribe to the impact goals of the bond, Triodos Multi Impact Fund did not invest in it, because issuer EDF is engaged in nuclear energy.”

There is growing interest in what I call ‘three-dimensional investing’: impact – being the return that cannot directly be expressed in financial terms – risk and financial return are equally important.
Raymond Hiltrop, Fund Manager Triodos Multi Impact Fund

Multiple returns

The market for impact bonds is young and grows quickly. Hiltrop expects the growth to continue in the coming years. “Financial markets obviously react to developments in society and comply to demand from investors. From this corner we have been seeing growing interest over the past few years in what I call ‘three-dimensional investing’: impact – being the return that cannot directly be expressed in financial terms – risk and financial return are equally important. I do hope and expect that within a few years impact investing will have become the new standard and that we won’t use the title ‘impact’ anymore. Thus we would have returned to the original role of money, that of being the lubricant of the economy, helping to create prosperity for everyone, and we would have left the idea of making money for the sake of making money. That is a good development.”

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