Impact bonds enable investors to invest in projects with clearly defined outcomes that are aimed at addressing some of the world’s biggest sustainable development challenges. Investor appetite for impact bonds is strong. The EU is posed to develop new guidelines that are likely to make it a mainstream market. Triodos Investment Management invests in impact bonds since 2015. In this article we explain how and why.
While achieving positive impact with its investments is Triodos Investment Management’s primary goal, in this case it’s also to help further developing and diversifying the market for impact bonds. In addition, Triodos Investment Management (Triodos IM) aims to reinforce the notion of the importance of adequate impact reporting on the basis of transparency, traceability and assurance.
Triodos IM has included impact bonds in its Multi-Impact Fund since 2015 and Sustainable Bond Fund since this year. Daily tradable, Triodos Multi Impact Fund targets an allocation of 30% in impact bonds. The Bond Fund’s allocation is slightly less, but it’s growing. Both funds only buy bonds denominated in euros to avoid currency risk, and the bonds must be from investment-grade issuers.
Since the first green bond ever was issued in 2007 the market has grown rapidly to roughly USD 162 billion of new issuance in 2017. With market sentiment shifting away from a sole focus on making money regardless of side effects, investor appetite for green bonds and social impact bonds is strong. Issues are often oversubscribed, with buyers wanting more than they are allocated. It means that even secondary trading in the first days after the issuance is attractive.
The impact bonds market moves in sync with non-impact bonds, so the benefit of impact bonds really is the social and/or environmental change they enable. “These days there would be very few investors that don’t have an impact bond strategy. There is a growing awareness. I don’t know of any financial organisation that’s not focusing on why they invest in certain industries or companies.”, says William de Vries, Fund Manager of Triodos Sustainable Bond Fund. “The EU is also poised to develop new guidelines that are likely to make it a mainstream market. The whole finance world is changing and focusing on impact bonds. They’re here to stay”, says Raymond Hiltrop, Fund Manager of Triodos Multi Impact Fund.
By far the majority of issued green bonds are still those related to environmental outcomes such as reduced CO2 emissions. “We would really like to see more flavours come to the market, more social impact bonds”, says Rosl Veltmeijer, Portfolio Manager at Triodos Investment Management, “but the fact is that measuring reporting of social outcomes is very difficult – it’s a barrier to the development of impact bonds with social goals.” Filippo Tognacci, SRI Analyst at Triodos IM, is optimistic and believes that “more social impact bonds will come to market - it’s not a matter of when but rather a matter of there being the right mechanisms to measure the outcomes”.
How Triodos differentiates itself
What sets Triodos IM apart from other investors is that it applies the same baseline to everything it invests in. For traditional bonds that provide funds to support ongoing operations, our methodology involves assessing the sustainability performance of the issuing company. For impact bonds we assess the sustainability of the specific project the bond is intended to fund. We don’t just buy certified green bonds; we carefully assess the project for its positive impact and its alignment with one of our seven transition themes. “In addition, the issuing company needs to meet our minimum standards. If they don’t, it’s a showstopper for us”, says Tognacci.
Green bond issuers must deliver on their promised impact and report on it, providing transparency, traceability and assurance. Triodos actively looks for issuers that guarantee a specific standard of reporting, and strongly encourages companies to prioritise actual outcomes, not just expected ones. “We believe that high levels of accountability can drive future business decisions and better sustainable strategy” says Tognacci. “Issuers welcome and highly value our feedback. We help keep them true to their word simply because we’re paying attention to the quality of their data.”
“Although we are not as big as other players in the market, we are considered a thought leader in this space. Other investors recognise our sophisticated investment framework and issuing companies do their best to have us on their order books. Issuers reach out to us. They see our interest as a seal of approval and know if we’re interested others will be too”, says Veltmeijer.
Triodos IM invests in both primary and secondary issues but prefers the first for two main reasons. “Firstly, because primaries often offer a higher return through an issue-premium when compared to bonds purchased on the secondary market”, explains de Vries. “The second reason is that by investing in primaries we support and help to further develop the green bond market.”
Another important aspect touches upon the principle of additionality. “We would prefer to finance projects that really mean a shift towards sustainability in the strategy and/or business practices of the issuing company, explains De Vries, “for example a company that wants to replace its lease-car fleet with electric vehicles. This is what we call ‘real additionality’ and it does not occur that often yet and therefore we are happy to also finance projects of issuers that are good but aim to do better. Ultimately, however, all green bonds we invest in, whether primary or secondary, ‘really’ additional or not, must fit one of our seven transition themes and thus materially contribute to sustainability.”
Buy and hold strategy
Triodos IM buys impact bonds with an issue size of EUR 400-500 million and hangs on to them for anywhere from three to seven years. It means on average a change in the portfolio of only about 20% a year compared to a typical bond fund of 50% a year. Our asset allocation of 30% also means that the funds can provide a good balance between liquidity and long-term commitment. “We don’t want to trade every day, but we have to take into account that within an active bond portfolio you might want to sell a bond, for example for a large-scale controversy that conflicts with our sustainable investment standards”, says Hiltrop.
People invest because they want to create impact, but they also want financial return. It’s very important says de Vries: “We do take into account the interest rate environment in our investment decisions. At some point you might conclude that the downside for the longer duration bond is bigger because there is just not that much upside anymore. So, when you select a bond you might want to select a bond with a shorter duration because they are safer. It also depends on where you think the market interest rates are heading but that’s like looking into a crystal ball – we don’t like doing that.”
Examples of impact bonds in portfolio
ALD Automotive - High impact, excellent reporting
The Positive Impact Bond framework proposed by ALD Automotive is one of the best-structured and most sophisticated we encountered so far and aligns with our Sustainable Mobility & Infrastructure theme. The purpose of the impact bond is the financing of eligible green vehicles. The bond fits naturally within the overall transition strategy of the issuer, which of course is focused on sustainable mobility, but is broader. ALD is also an active explorer of new possibilities to provide mobility services in a shared or as-a-service format, in line with circular economy principles.
The quality of the impact reporting is very high. Measurements are based on a Life-Cycle Analysis (LCA) approach, which takes into account the impact of the production, use (incl. fuel and/or electricity production) and end-of-life treatment of cars. ALD clearly recognizes that it has a direct economic self-interest in providing high-quality impact measurements (as well as good underlying impact), as they can translate this into a competitive advantage for clients who are increasingly sustainability-aware and subject to environmental regulation.
SGP – strong additionality
SGP's Green Bond Programme is dedicated to financing the new Grand Paris Express electrified and automatic metro project. This impact bond fits our Mobility & Infrastructure theme and, in some respects, also our Social Inclusion and Economic Empowerment theme. The project matches closely our view on sustainable urban mobility. The bond has a strong additionality profile, given the high level of ambition of the Grand Paris Express greenfield project and the issuer behind it, strategically relying on green bonds for funding.
To our knowledge, SGP is the first issuer to rely solely on impact bonds. It has the strong ambition to become a key player in the green bond market, building an entirely green curve with issue sizes of up to EUR 3 billion. The project, the total cost of which is expected to reach EUR 35 billion, will be entirely debt-financed.