Commentary

A Climate-aligned Portfolio Shouldn’t Cost the Earth

Bruno Bamberger, Solutions Strategist at AXA Investment Managers, highlights potential cost-efficiencies for institutional investors transitioning to net zero.

It’s hard to avoid the visible evidence of the climate transition. Electric vehicles on the roads, solar panels in your neighbourhood and national governments exhorting each other to do more. The chances are you’re seeing even more of this now than you were at the start of the year.

Investment portfolios, however, tend only to be visible to industry insiders. But, if you know what to look for, the transition to a more climate-aligned allocation of assets is just as visually impactful and profound.

However, delivering this impact is a material undertaking. Inexperienced hands could also make it a costly one. For anyone closer to the start of the transition, and cognisant of potential costs, we believe there are a number of considerations to think about.

The first is opportunism.

Trading bonds can be costly. For asset owners with an eye on costs, the most effective (and particularly the most cost-effective) method of creating a climate-aligned portfolio is to do so either when you set up a new mandate – OR top up an existing one.

It is far more straightforward to start or top up a mandate and use this fresh flow of money to tilt the portfolio towards climate-aligned securities, thereby altering the whole balance and structure of the overall portfolio. This means that turnover stays low – and so do the costs.

We believe this point is particularly pertinent for pension schemes at the moment. If you are a defined benefit investor for example, you may have seen your funding level improve dramatically and therefore be either currently undertaking, or about to embark on, a strategy to de-risk parts of your portfolio.

For a defined contribution scheme, we are seeing more money than ever going into fixed income strategies, as people age and also start to de-risk towards retirement.

In both cases this means that money will already be changing between strategies, providing a perfect opportunity to align this activity with a move towards a more climate focused credit portfolio, achieving both goals at the same time.

Moreover, we believe there is an optimum window of opportunity for schemes to act now, with the divergence in credit spreads between lower-and higher-rated issuers at its lowest point in the post-Global Financial Crisis era.

The same lack of dispersion holds between climate leaders and climate laggards – with no premium to pay for investing in lower emitting or more climate-aligned bonds. This means that now is potentially one of the cheapest times for pension schemes to integrate climate factors into their investment processes.

Nimbleness and scale

The next considerations are nimbleness and scale.

We all know the green bond universe has exploded. New bond issues this year alone are likely to aggregate up to US$ 500 billion, according to Axa IM research. It’s hard to think of a debt capital market that has ever grown at such a pace.

This means that the opportunity to take part in the new issuance market is huge.

The cost advantages associated with this should not be underestimated. For credit trading costs, AXA IM research suggests investments will incur a circa 0.6% ‘round trip’ cost – 0.3% to buy and 0.3% to sell. A cost which can be avoided when making investments via the new issuance market.

Of course, there are caveats related to the green bond market that must be taken into consideration – both in regards to its relative overall size and in terms of being discerning as to whether all bonds are as green as they’d like you to think. But the universe and variety of issuers is continually expanding and going global in your allocation will also help to combat this.

Moreover, the opportunity set is not limited to just the green bond market – and good climate-aligned portfolios should also be robustly diversified ones.

Beside the cost factor, diversification into issuers with climate aligned corporate strategy and in decarbonising industries can help offset potential challenges in the green bond market and contribute to helping the overall climate transition. So, it’s important that investors keep their eyes open to such opportunities.

New regulation such as the EU taxonomy for sustainable investments should provide helpful guidance in this area, alongside that of your asset manager.

Patience in an emergency

Fourth, and while not purely cost related, we believe it is important to have patience once you have implemented your portfolio changes.

Clearly time is pressing. The science-led deadlines for action on environmental issues are not negotiable. Neither are legislation and regulation spurred by the science.

And yet, encouraging companies to change is not an overnight task. Engagement can take time. Our analysis and experience say that it can take months, sometimes years, of dialogue with the senior management team of a company to work through and implement the changes needed in order to stay on as a holder of its securities.

This requires patience.

We feel comfortable saying this partly because we believe that engagement can have profound impact – and partly because the alternative to engagement is disinvestment, and this should always be a last recourse, especially considering the financial costs of trading in credit markets.

When taking all of these factors into account, we believe there’s no reason why transitioning a fixed income portfolio towards climate goals should cost the earth.

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