Separating the green bonds from the greenwashed
Rhys Petheram, Head of Environmental Solutions, explains why it could be a good time for green bond investing, as supply and demand look increasingly mismatched.
A green bond is a bond issued by any organisation, as long as its proceeds are earmarked for environmental, or ‘green’ projects. These green projects might have already happened, or they might be happening in the future; proceeds may be put in dedicated accounts, or they may not; and these bonds are sometimes issued by pure-play green companies, though they can also be issued by governments, neutral companies like telecoms, or even by coal power generation companies, for example.
The wide-ranging spectrum of impact you can get from green bonds causes some well-founded concerns for investors about greenwashing in this space. As green bonds are typically not asset-backed deals (rather it’s an earmarking process) it means they are not driving change in their own right. However, they have become an important part of the journey for companies trying to implement sustainable strategies. Green bonds can offer many exciting investment opportunities that align with delivering solutions to environmental challenges, though greenwashing concerns are certainly something we take seriously as investors in this space and detailed due diligence is vital.
This year and into 2023, we believe there is scope for compression in green bonds. We expect to see a sort of ‘lightbulb’ moment, as a lot of larger funds are going to have to start reporting, either for EU taxonomy reasons or to meet commitments under SFDR, and green bonds – for better or worse – will be perceived as having reporting advantages which we believe will increase their appeal to investors. Furthermore, while last year we saw around $1tn of supply in sustainable bonds, we think this is unlikely to be replicated this year given macro risks as well as tightened financial conditions.
As we entered 2022, we expected the US market to drive growth in this area – currently, it only accounts for around 10% of the green bond market, compared to as much as 50% of the wider global corporate bond market. But while there’s a lot of scope for growth in the US, this growth doesn’t seem to be materialising right now. As a result, a supply and demand mismatch means we could see green bonds trading at a premium to other corporate bonds. Right now, though, the average premium is only around 2-3bps.
In terms of the wider picture, while we are unsurprisingly more cautious on risk than we were at the start of the year, valuations have adjusted significantly especially on the investment grade side. This is largely because there hasn’t been support from reference yield curves – government bond yield curves – which underpin investment grade yields, as you would usually expect. With global investment grade bonds now yielding an average of 3%, we think investment grade names are looking attractive for the first time in a long time.
The importance of ESG engagement for value investors
Ben Whitmore, Head of Strategy, Value Equities, outlines his team’s investment philosophy and approach to identifying companies for generating returns over the long term.
My team and I are value investors. We believe that the key determinant of future returns is whether the valuation initially paid for a security is high or low relative to its long-term history. There is a significant amount of evidence showing that securities purchased at a low valuation have historically delivered above average returns over time.
Our team’s investment process is focused on identifying lowly valued securities with resilient balance sheets and good businesses in an attempt to capture the value premium. We do not attempt to make forecasts at either the company or macro level. Forecasting the future is inherently difficult and unreliable, especially to do so consistently, so instead the aim is to understand where a company’s current earnings sit within the broader historical context.
As value investors we are investing in companies which have experienced issues; something has typically gone wrong in order to make their valuations low. It is not unusual for this to be an ESG issue, but we don’t simply exclude companies based on ESG ratings. Instead, we are looking for opportunities to engage where we believe we can improve shareholder value. Engagement here is absolutely crucial for us, as is the direction of travel as companies need to demonstrate progression.
One of the companies that we hold in our strategy is BP, which has been in the spotlight following the Russian invasion of Ukraine. BP owns 19.75% of Rosneft and have committed to sell this stake – although it is not currently clear who will buy this stake and at what price. We fully support BP’s decarbonisation strategy but believe the transition will take longer than the market expects, and also require the use of significant amounts of energy. The company is very cash generative with a free cash flow yield of at least 15%, therefore we think the valuation afforded to it is too low. As such, our long-term investment case for the company remains intact.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.