This episode features Steve Liberatore, Nuveen’s Head of ESG/Impact for Global Fixed Income.
Listen now and learn:
- The case for ESG bonds
- What makes a bond ESG or sustainable
- Why ESG bonds impact is more tangible than an ESG stock investment
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Show Notes
This episode features Steve Liberatore, Nuveen’s Head of ESG/Impact for Global Fixed Income. Steve is the lead portfolio manager for Nuveen’s Core Impact Bond, Short Duration Impact Bond, and Green Bond funds.
Steve serves on the ICMA Green Bond Principles Advisory Council and was a member of the initial executive committee. He is also a member of the UN Capital Development Fund’s working group on Climate Insurance Linked Resilient Infrastructure Finance and serves on the UN’s Joint Sustainable Development Goals Fund’s Blue Economy Investor Advisory Group. Finally, Steve also serves on S&P’s Global Ratings ESG Leadership Council.
Needless to say, it’s hard to find a better resource for learning about ESG and Impact fixed income investing. Here are my notes from this awesome conversation…
The Benefits of Impact Fixed Income Investments (1:35)
Historically, the concept of impact investing has been focused primarily on private equity and venture capital. But over the past decade or so, there’s growing excitement and understanding of the ability of public fixed income to drive impact investing.
With public fixed income securities, managers can get access to very specific outcomes through the structuring of a transaction and being able to control the proceeds. That’s something you can’t do in other asset classes.
There’s also a wide variety of types of fixed income securities that can be used to drive impact beyond corporate debt, including agency securities, NGOs, municipalities, global supranationals, and structured securities (ABS, CMBS, etc) that have a direct and measurable outcome associated with the underlying capital.
In short, fixed income is a great way to access companies or entities that are doing great things from an ESG and impact perspective – far more accessible to give them capital via fixed income than to do so via private equity or venture capital.
Incorporating Responsible Investing into Bond Selection Process (3:40)
Steve explains Nuveen’s process of incorporating responsible investing into fixed income.
It starts with the concept of ESG leadership – or what I tend to call a best-in-class approach – to define the eligible universe. Using their internal responsible investment team and third-party providers, they identify issuers who are leading the way in their respective sectors on environmental, social, and governance criteria.
This is usually where the process stops for the ESG equity strategies that seem to be most popular these days. There’s nothing wrong about that, but allocating capital to public equities in this manner has limited direct impact. That’s what makes the next part of Nuveen’s process so intriguing.
Once the eligible universe is defined using the ESG leadership process, they begin looking for securities with a direct and measurable social and/or environmental outcome associated with it. And (again) because fund managers involved in a new bond issuance can influence how proceeds are utilized in those transactions, they are able to drive direct and measurable impact.
Steve and Amy O’Brien (Nuveen’s Head of Responsible Investing) created an impact investing framework in 2007, which they continue to review and update annually, that is focused on the concept of transparency and disclosure. They have an amazing Impact Report, which you can download here.
ESG Leadership vs Impact Investing (6:20)
The concepts of ESG leadership and impact are interrelated in a lot of ways, but they’re distinct.
Whether you are running an ESG fixed income fund or not, research suggests there are financial implications to how an issuer performs on environmental, social, and governance criteria. That’s particularly important in fixed income, which is an asymmetric payoff asset class where outperformance over time is more about avoiding the losers than picking the winners.
The ESG leadership process is really about identifying the best operated and managed issuers because over time you’d expect them to have a more stable free cash flow profile – and free cash flow is critical to bondholders being repaid.
In many ways, ESG analysis is just another layer of risk mitigation because those best performing issuers are taking into account a wider array of risks to their operations. Steve uses the oil and gas sector as an example for how using ESG criteria can translate into a potential financial outcome.
Rather than exclude oil and gas issuers, an ESG leadership approach invests in the oil and gas issuers who are the best stewards of the environment because over the long run they win more business, have lower long run capital expenditure requirements, and they’re fined less. As a result of those factors, they have a more stable free cash flow profile, so they’re more likely to be able to repay bondholders over time.
The impact investing side is slightly different because the objective is direct and measurable outcomes. For example, can you invest in a geothermal power plant or a series of affordable housing projects or funding gender lens or providing capital to underserved populations.
Because impact investments are a little more unique and esoteric, they carry a little bit more spread simply because they’re not as well understood. As Steve explains, that’s more likely to lead to outperformance in an up credit cycle.
Combining these two concepts (ESG and impact) where appropriate in a portfolio is a very powerful combination, regardless of if you’re interested in aligning your money with your values.
The Importance of Engagement Efforts (11:27)
Engagement has the ability to deliver capital in ways that lower the cost of capital for issuers or pools of assets or technologies that can create a more sustainable future. But getting involved early and often in the issuance process is critical to driving the outcomes you desire.
Nuveen’s size and reputation for being innovative and willing to look at unique and different types of structures makes their engagement efforts particularly effective. Steve notes that in 2021, their team had 164 different engagements where they spoke with issuers and even some industry groups around structuring impactful transactions.
In these instances, the issuers are reaching out to Nuveen upfront to get views on the structure of a bond and/or what the issuer would need to do in order to get them involved.
Fixed income is an over-the-counter market, so everyone is treated differently. How you’re treated at new issue is going to really depend on kind of how much impact/influence you’ve had in the structuring of a transaction. So if you’re able to participate early, you’re able to direct the outcome in a way that fits your frameworks and impact objectives.
How A Bond Today Impacts a Bond (and Sustainability) Tomorrow (14:30)
There are more and more definitions in the sustainable bond space.
- A green bond is a transaction whose proceeds are being utilized to fund an environmentally beneficial project that is terrestrial, or basically “on ground.”
- A blue bond is a transaction that provides funding for investments that have an environmental benefit, but are ocean-based.
- An orange bond is a transaction that provides funding for gender equity opportunities, providing capital to underserved women.
The definitions of these are fairly consistent – it’s really about where the capital is going and who is benefiting from that deployment of capital. When you are funding a project, you have a dual mandate to create impact and also generate an investment experience that mimics something like a core bond holding. That’s a tough thing to balance. Looking globally for these opportunities can help.
We talked about a “rhino bond,” which was the first wildlife conservation security that’s ever been issued, and it was issued by the World Bank. The proceeds are funding wildlife conservation for black rhino population growth in two game parks in South Africa. The repayment of those funds comes with what is called a success payment – the growth rate of the black rhino population will determine the ultimate payout on the transaction.
The rhino bond is an inaugural type of transaction that Steve believes can be a template they can utilize going forward to deploy capital more efficiently and more effectively going forward. Other examples of this type of innovation are the Seychelles blue bond or the IFC forest bond.
In a lot of these instances, there’s an opportunity not only to benefit that particular issuer, but the issuers that come after them as well. Steve thinks renewable energy (solar, wind, etc) is the best example for this. Just like Moore’s law with semiconductors – roughly every two years, the number of transistors on microchips will double – the more you invest in something like solar panels, the cheaper it becomes and the more efficient it becomes over time.
By investing in solar or wind today, you’re helping reduce the cost for the next solar or wind project going forward. That helps society get to a place where the cheapest form of marginal power at utility scale level can be a renewable source (in the U.S. this is true of solar in the Southwest and wind in the Midwest).
And now you’re getting to a point where this concept of delivering capital and lowering that cost of capital is transitioning the conversation into one that’s a financial decision, not purely a conservation/sustainability issue. That’s a real tipping point to transform the way that investors in the markets think about how to invest responsibly.
The Effect of Impact Bonds on Financial Markets (19:37)
Yeah, it’s really starting to change the nature of the fixed income market as a whole. Last year was the first time issuance of securities labeled as being ESG, green, social, sustainable, etc eclipsed $1 trillion. And now there is $2.5 trillion worth of outstanding bonds right now.
It’s still a very small portion of the market as a whole, but it’s the most rapidly growing. Investor demand continues to increase. Institutional clients who are focused on the fact that their regulators, their clients, their employees are more interested in their overall sustainability.
On the individual side, the two fastest growing groups of investors are women and millennials. Those two groups also have the highest preponderance for wanting to incorporate ESG or impact into their investment decision.
Responsible investing and capitalism are not mutually exclusive. When done correctly, they work extremely well together. And now we’re getting to a place where you have long run performance metrics that are showing the opportunities available to someone looking for those types of investments – and, just as importantly, you don’t have to sacrifice performance to be a responsible investor.
The Future of Responsible Investing for Fixed Income (24:30)
There is a wide amount of interest across gender, race, political views, and affiliations.
For an advisor, the ability to talk about ESG and impact deepens the conversation with clients because you’re getting at the heart of what they’re trying to do with their money.
That opportunity to expand and deepen the conversation around what you’re really trying to accomplish with your capital is important.
Going forward, Steve thinks there will be much more granular opportunities to invest from an impact perspective. The rhino bond we discussed earlier is a good example, but Steven also points to an opportunity set that invests in underserved women in Southeast Asia in a way that provides not just societal benefits but also environmental benefits.
And obviously renewable energy is a huge driver, and Steven thinks that has the greatest opportunity. Just like mortgage-backed securities have helped make home-ownership more affordable for more people, asset-backed securities have the potential to do the same by making solar more affordable to a greater portion of the population – eventually to the point at which it actually saves people money and doesn’t cost more.
Resources
- Nuveen’s Impact Report (Summary)
- Nuveen’s Impact Report (Full)
- Impact Investing in Public Fixed Income Markets (White Paper)
- Innovation in ESG Municipal Bond Investing (White Paper)
- International Capital Markets Association (a good primer on green, social, and sustainability bonds)
- The Seychelles blue bond
- The IFC forest bond.
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