Triodos Euro Bond Impact Fund invests in a well-diversified portfolio of sovereign, sub-sovereign, and corporate bonds. The fund selects tradeable bonds of solid issuers that make a real contribution to the transition to a sustainable economy and society.

A significant part of the fund’s portfolio is invested in so-called green or social bonds that meet the standards of the International Capital Markets Association. “But we do not blindly rely on such labels; we take a critical look at what it is that we would be funding. We do this by not only making a detailed analysis of the framework of the green or social bond, but also by assessing whether the issuer meets our minimum standards. During the life of the bond, we keep our finger on the pulse and continue our dialogue with the issuer. This integral approach sets Triodos Euro Bond Impact Fund apart from other sustainable bond funds”, comments Van Herwaarden. 

Strict standards for sustainable impact

Before investing in a bond, Van Herwaarden asks questions such as: “How sustainable is the issuer? Do the activities or the projects that are being funded contribute to a better world?" “We do not blindly rely on the existing ESG data, on data from the past, but dig deeper and especially take a forward-looking approach. What does the sustainability agenda of the institution or company look like? What type of business model does it have? What is important to us is the issuer's behaviour and intention to actually bring about change in line with the sustainable transition.”

In case of green or social bonds, the fund mainly considers additionality: “How do the activities that are to be funded contribute to the transition to a more sustainable economy? Are the proceeds to be used for refinancing existing projects or for funding new projects?” In practice, the fund invests mainly in bonds that are issued to fund new projects and to a lesser extent in bonds of which the proceeds are used to refinance existing projects.

The strict nature of the investment criteria for the Triodos funds is evidenced by the fact that all Triodos funds qualify as article 9 funds under the new European transparency rules on the negative impact of investments (SFDR). “Article 9 is the category with the strictest criteria. This means that as from next year, we will have to report even more comprehensively on sustainable indicators and ESG risks. We are making the necessary preparations and are confident of a good outcome”.

An eventful year for bond investors

2020 was a turbulent year for bond investors, but the fund’s sustainable portfolio did not disappoint. Over the past year, the fund realised a return of 3.6% before expenses, in line with the (non-sustainable) benchmark (3.7%).

The marginal underperformance relative to the benchmark is attributable to the relatively smaller proportion of the portfolio that was invested in riskier bonds. “Risk management is important for the fund”, says Van Herwaarden. The fund's performance in 2020 was positively impacted by the adjustment of its yield curve positioning, in anticipation of lower yields after the pandemic broke out. “That strategy paid off, as yields indeed moved lower over the year, despite bouts of volatility.”  

Furthermore, the fund managed to respond effectively to the sell-off at the start of the Covid crisis. Many investors were looking to quickly reduce their risk exposures and because of the low liquidity of the corporate bond markets also sold government bonds. Van Herwaarden: “Initially, this also had a negative impact on our portfolio, but we used this development to add to our positions in government bonds and relatively safe corporate bonds at low price levels. The subsequent market recovery had a positive impact.”

Defensive bonds overweighted

Around 30% of the portfolio of Triodos Euro Bond Impact Fund is invested in government bonds. This constitutes an underweight position relative to the benchmark, but the large position in semi-government bonds results in a substantial overweight for defensive bonds. "Consequently, so far this year, in the current risk-on environment, we have not quite been able to keep up with our benchmark”, comments Van Herwaarden.

However, the risk-on environment is based on optimistic expectations by investors that we have a strong economic recovery ahead of us. This is already becoming apparent in the US, partly in reaction to President Biden's generous fiscal support package. Inflation expectations are rising, and capital market rates are moving up. Should European bond investors also be concerned about rising yields?

Van Herwaarden: “Eventually, interest rates will also start rising more substantially in the Eurozone, but based on the current European macro-economic conditions we do not believe this to be imminent. The growth recovery here is taking longer to materialise and inflation is still low. Fiscal stimuli are more modest, and the European Central Bank continues to buy up bonds on a large scale - percentagewise even outpacing the Federal Reserve. We therefore do not expect significantly higher interest rates  before the end of the year. Still, it makes sense to start reducing interest rate sensitivity in anticipation, because we cannot completely isolate ourselves from what is going on in the US. Higher US yields will attract capital flows and may cause some price pressure in the Eurozone.”

Finally, Van Herwaarden has also reduced the fund’s credit risk exposure. “The real damage that the Covid crisis has done to companies is yet to become clear. Many companies have been kept afloat by means of support measures. This implies that the number of downgrades may increase, especially for lower-rated companies. 25% of our portfolio is invested in bonds with a BBB rating, which is a much smaller percentage than for the index. This is in line with the fund’s objective to realise a stable and predictable return. In addition, we of course keep aiming for maximum positive impact, in line with our strict principles."