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The role of social bonds

Social bonds

For financial professionals only

The coronavirus outbreak has given rise to a few new concepts, like social distancing and social bubbles, and lockdown has definitely highlighted the importance of our social connections.

But in this article, we explore social bonds of the fixed income variety, and how the recent health crisis has increased the popularity of this relatively new ESG investment vehicle.

 

What are social bonds?

Similar to green bonds, which support environmental projects such as clean energy, or the decarbonisation of buildings or transport – social bonds are a fixed interest investment vehicle issued to tackle a particular social concern.

Social housing is the most well-established corner of social bonds. Issues in social housing tend to be above £350m – and are often structured as senior unsecured bonds to give a moderate risk-adjusted return. Recently, there have been more issues in other sectors, like Pearson’s June 2020 £350m issue to fund education and Co-op’s May 2019 £300m issue for fair trade projects.

Green bonds are somewhat more established than social bonds, growing from $167bn in 2018 to $255bn in 2019, and forecast to top $350bn in 2020 (source: Climate Bonds Initiative). But with a healthcare crisis sweeping the globe, and a clear demand for ESG investments, the market in social bonds is growing in size, and popularity. Green bonds tend to be issued by a wider range of companies compared to social bonds.

Much of the recent social bond issuance has been by supranationals to fight COVID-19. The World Bank’s $8bn Sustainable Development Bond in April 2020 was the largest ever USD denominated bond issued by a supranational. It received an incredible 12.5bn of orders from 190 investors. Other recent COVID-19 bond issues were even further oversubscribed; in April the European Investment Bank’s 1bn euro issue received orders of 7.3bn euros.

 

How do you choose social bonds?

As with any bond, the investment case needs to stack up in terms of its coupon, credit risk and liquidity.

While the market is growing, it still lags the wider bond market. Issuance for US investment grade bonds reached over $1.1trn in 2019 (source: Securities Industry and Financial Markets Association) – five times higher than green bonds and many multiples more than social bonds. The chart below shows year on year issuance, for context.

Green bonds issuance is growing, but from a low base ($bn)

This means that liquidity is the most obvious concern when it comes to Green and Social Bonds. For example, some fund managers will invest in charity bonds, which can have a big social impact but are often small issues. In these circumstances, the manager must undertake in-depth analysis to make sure the issuer is credit-worthy and that the coupon is enough to compensate for the relative illiquidity.

At the other end of the spectrum are issues by supranationals. They are a high quality issuers with sufficient liquidity. Because of this, the likelihood is that the coupon will be lower.

What’s unique with these bonds is that their ethical credentials also need to be scrutinised. What will the monies raised be used for? Will the monies be strictly ring-fenced? What will be the quality of post-transaction reporting?

It’s generally easier to measure the impact of green bonds, which could be quantified as a reduction in carbon emissions. This can be trickier for social bonds, where the objective may be qualitative, for example to improve child development.

There are independent verification agencies who may assign an official “green” or “sustainable” label to certain issues. However, some issuers may not apply for this verification, particularly smaller companies who are more cost constrained. Also, some bonds are currently trading at a premium by having these labels, which may reduce the attractiveness of the investment overall.

 

How are social bonds used in Parmenion’s portfolios?

To navigate this complex marketplace, we use leading sustainable bond fund managers across the PIM Strategic Ethical Active Profiles A, B, C and D. These managers have been selected based on our rigorous, risk focused due diligence process.

Our fund managers look beyond the labels and undertake their due diligence to independently assess whether a bond fits their criteria. For example, a green bond with tightly defined parameters can meet a manager’s ethical criteria to invest even if the standard issue from the same company would not. For example, a green bond focusing on sustainable energy issued by an energy company whose main business includes fossil fuels.

In general, our managers see this as an interesting area, and they expect to increase their allocations over the next 12-18 months, subject to finding attractive opportunities. They’re also highly conscious of “impact-washing” and “green-washing”.

The best social and green bonds will have a clear strategy, strong ring-fencing of monies, and transparent reporting to demonstrate the positive impact your ethically minded clients are looking for.



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