WALL Street’s do-good investment boom is finally taking notice of the credit markets. Sustainable investment assets grew 37 per cent last year, according to Bloomberg data, but the majority of those funds focus on stocks.

That’s leading to some awkward conversations on Wall Street, as wealthy investors and foundations increasingly want to align their entire portfolios with their social mission, but are finding few opportunities to do so in fixed income.

“Most of the people who are interested in incorporating environmental, social and corporate governance (ESG) are interested in doing so throughout their portfolio,” says Rui de Figueiredo, co-head and chief investment officer of the Solutions and Multi-Asset Group at Morgan Stanley Investment Management.

Of almost 1,900 ESG funds tracked by Bloomberg, 15pc invest in fixed income versus 62pc in equity. On an asset basis, that figure is even smaller, with fixed income representing about three per cent of the $491 billion invested in such funds.

Bonds, though, have the potential to be a popular ESG asset class for impact investors, those who look to generate environmental and social outcomes along with financial return. Fixed income typically attracts investors with longer time horizons who might be more philosophically aligned with environmental and social issues, says Mike Amey, head of sterling portfolio management and ESG strategies at Pimco Investment Management Co.

To fill the gap, asset managers are looking at the existing debt market with fresh eyes, tapping into potentially overlooked asset classes such as affordable housing and development bank debt to find investable opportunities for sustainability-hungry clients. They’re also trying to build infrastructure, such as benchmarks, that will support greater liquidity and investment levels in these products.

Here’s what’s going into sustainable bond portfolios.

Development bank debt: High-grade debt issued by the World Bank and other development banks offers some of the best-performing do-good credit on the market, according to UBS Group AG.

Green bonds: The market for environmentally friendly bonds is expected to hit a record $170bn in new issuance this year, but the bonds are in relatively short supply, according to Bloomberg NEF. Green bonds represent less than 0.5pc of the global fixed-income market.

Most deals are oversubscribed, and their environmental credentials appeal to long-term investors who buy and hold investments. If you can get your hands on a green bond, you’ll find the sector has been dominated this year by sovereign, local government, and financial issuers.

Social and sustainability bonds, which concentrate on themes such as responsible farming or housing finance, are also a budding area, with about 25 deals this year. But there are only about 110 bonds on the market, representing a total issuance of about $47bn, according to Bloomberg.

Municipal bonds: The municipal bond market is an “abundant source of potential investments” in ESG, says James Iselin, head of the municipal fixed-income team at Neuberger Berman Group LLC. Debt issued by local communities can have a positive effect, funding energy and water-treatment projects, schools, and public transportation; it can also help investors lower their tax liabilities.

ESG-rated bond portfolios: Fund managers such as Pimco, Fidelity Investments, and Brown Advisory Inc are building their sustainable fixed-income funds by selecting bonds issued by companies that perform well on ESG ratings maintained by third parties such as Sustainalytics and MSCI Inc.

Real estate: When the Ford Founda­tion last year committed $1bn from its endowment to impact investing, it said one of its top initial investment targets would be affordable housing. Community Capital Management Inc, an impact investing company that oversees about $2.3bn, slices up portfolios so investors can use their fixed-income strategies to support housing in a number of categories such as disaster recovery, minority neighbourhoods, arts and culture programs, and sustainable agriculture.

Environmentally-friendly buildings are also presenting opportunities. Federal National Mortgage Association, for example, was the largest issuer of green bonds in the world last year, selling more than $27.6bn in green mortgage-backed securities in 2017, up from $3.6bn in 2016.

The water and energy efficiency modifications made to the properties in those portfolios will likely reduce utility bills, according to Fannie Mae.

CDFIs: Community development financial institutions, which provide affordable lending to low-income and underserved communities, are gaining traction with impact investors. Banks have been the primary investor in the area for years, thanks to the 1977 Community Reinvestment Act.

Bloomberg/The Washington Post Service

Published in Dawn, The Business and Finance Weekly, September 3rd, 2018