Whether it's project-based green bonds, social bonds, or sustainability-linked bonds, fixed income is increasingly becoming the “go-to” for mature companies looking to fund CapEx as they transition to a sustainable future. Bernstein Sustainable Credit Portfolio Manager Shawn Keegan discusses the brave new world of sustainability-focused fixed income, noting, “The train has left the station and there’s really no stopping where it goes.” Their overview of the landscape includes key questions for UHNW investors, investment committees, and fiduciaries looking to complement their responsible equity allocation.
00:08 - 00:47
Welcome to On Purpose. I'm your host, Travis Allen, senior investment strategist and national director of Purpose Driven Strategies at Bernstein. Today, I'm delighted to be joined by Sean Keegan. Sean is a senior vice president and a member of the Credit Portfolio Management Team at Bernstein, focusing on US and global portfolios. He also specializes in responsible investing and leads our investment team focused on taxable, sustainable bond solutions. Sean's also a member of AB's Environmental, Social and Governance Research and Stewardship Group and helps lead our relationship with Columbia University. Sean, welcome to the podcast.
00:47 - 00:57
Thank you, Travis. I'm very excited to hear the talk today about thematic investing in fixed income. It's a new field is revolutionary, and it's the future of fixed income.
00:57 - 01:26
Well, Sean, that's actually where I wanted to start because I feel like in the world of responsible investing, so much of the talk ESG is around equities. You know, what do you hold? What don't you hold? And I feel like there's a huge opportunity to build compelling strategies in fixed income. We've talked about some of those strategies in the past that we've developed at AB. But why do you think more investors should spend time focusing on their bond portfolios for strong ESG and sustainability investment solutions?
01:26 - 01:47
Well, I think, first off, it's good sound financial sense. You want to be a sustainable company that's looking forward not only about their financials, but how do they affect both their customers, where they live, how they interact with the outside world? That is important. I think more investors are looking at that. We as consumers certainly think about that as we buy products and think about it.
01:47 - 02:25
And then the second part is, I think when you look at the equity market versus the fixed income market in terms of sustainable investing, the equity market, to a sense, is where the innovation is happening, right in terms of companies investing in solar panels and new technologies that will reduce greenhouse gases. What's really interesting about the fixed income department is the fixed income side is that's where we can build scale. As that innovation starts to creep into the market and companies want to do bigger and bigger. The fixed income market is where you can get that scale on a 20 trillion dollar corporate bond market. Just to say that can build that scale and not have to reduce, you know, not affect the equity pricing if it comes to that.
02:25 - 02:53
I'll give you a great example. That is, if you look at General Motors and Ford, they are big issuers, big users of the fixed income markets, and you can see they are in a big transition from the internal combustion engine to electric vehicles. That's going to take scale, whether it's to build batteries, retrofit factories, and for them to come naturally to the fixed income market, and we can support that, I think is a natural byproduct of where fixed income is going in the future.
02:53 - 03:10
I think what's so interesting about the point you're raising is that it may mean that the names that you have in your sustainability focused fixed income strategy may look different than the names you have in your equity strategies because you're focused on what the bonds are going to be used for. Is that right?
03:10 - 03:49
Yeah, I do. It's what the bonds are going to be used for. It's different fields and industries are more tilted towards the fixed income markets. So say banks and utilities. Where banks are very important, they're that intermediary that's going to fund this transition and address those climate change. Utilities are transforming. How do they look at their generation? How do they make power and then do that moving away from those dirty industries towards clean and renewables? And those are just natural, as you say, Travis, natural users of the fixed income market. They tend to be more mature companies that need that scalability to fund the capex and those transitions, whatever it is they're trying to achieve.
03:49 - 04:14
Well, I know that one of the things you and I have talked about in the past is the United Nations Sustainable Development Goals as a common framework that's being used in the world of responsible investing. I know that's something important to the way you think about sustainability and fixed income, so maybe give us a sense for how you think about or how you use the UN SDGs in order to find corporate bonds or other bonds that have positive societal outcomes.
04:14 - 04:41
Yeah, I think the first step is just taking a step back of what do we like about the UN's Sustainable Development Goals? There's a lot of problems in society, whether that's diversity, lack of education, poverty, the climate, and these broad sustainable development goals really address all of those things. And I think that's important. So how do we do that? We look at what companies do, what do they sell, what do they build and align that with the underlying Sustainable Development Goals?
04:41 - 05:37
So it could be. I'll go back to my example of a utility there, power generation. Are they doing it responsibly and sustainably? You go to health care companies using their capex and things to build out new modern technologies in the health care field. You look back to a lot of companies. What they did was provide a lot of those companies are developing. The vaccine came to the bond market. So really digging down and understanding what a company does and what they sell and how does that align positively towards achieving? The other thing is we have a lot of e-commerce, right, and that's very powerful. People don't think about that in terms of poverty and lifting people out of poverty. But if you can use a tool that you can build a product yourself at your home and do that and have a platform to sell that out to the general public, that's addressing poverty that someone may not have. So technology is also very important in the way we look at examples of companies, what they do, what they sell, and how does that align with the sustainable development goal.
05:38 - 05:50
So glad you made the point about technology and financial inclusion, because as we drive around the places where we live, we don't see a lot of payday lending or auto title loan businesses in wealthy areas.
05:50 - 06:29
Obviously, the need for financial services, financial inclusion, access to financial institutions in less well-off areas is really profound. It's hugely important to what we do and what we look at both in the US, but also on a global basis in things that we're looking at, and it can go to small and medium sized enterprise lending. Think about what's happened over the last 18 months. These small companies and restaurants need our support, right? They need that financial support to get themselves back into where they were pre-pandemic. That's going to take a lot. So I think those are all important things to look at. So many people, when they think about responsible investing, focus on one very narrow area,
06:29 - 07:05
right, whether it's climate, poverty, diversity. But really, when you think about it, those things are all very interconnected, in terms of how climate change can affect cities where there's more poverty than the suburbs, or wealthier neighborhoods have the resiliency and the financial capital to build up against those climate change, whether it's putting solar panels on the roof, moving to higher ground. If you live in a poor area in the city, in a city that might not be doable for you. And I think these things are all interconnected, and I think as we look back to the SDGs and understanding the Sustainable Development Goals, how those are all interconnected are very important to what we do.
07:05 - 07:33
I know that in building out the investment strategy, you just thought it was important to go beyond just having exposure to corporate bonds and you have exposure to green bonds, social bonds, and sustainable bonds. And I know more about green bonds than I do about the other two. But my understanding is green bonds are still a pretty small portion of global bond issuance. And so my first question is, are green bonds mature enough to provide an attractive risk return opportunity today?
07:33 - 08:29
They are. I think we've passed a milestone this year of over one trillion in green bonds and sustainable and all the label bonds. What's also very important is the change that we've seen in the issuance over the years. I've been in the green bond market since 2011, when the first one came out and I bought my first one in 2015. There's a lot more issuers that are doing it. There's a lot more attractive financial return that can be doing this as more companies think about their sustainability and issue it. So we've seen investment grade corporate issuers come in. We've seen emerging market. We're now seeing high yield. We're seeing dirty industries that are starting the transitions of oil companies like BP and Chevron and things like that, thinking about it. So not only the size of the market is getting much better, but the depth in terms of issuers, I think is growing exponentially. And I think the train has left the station and there's really no stopping at this point where it goes overall.
08:30 - 09:14
So yeah, I do think and we have on our global fund in March, during the epicenter of the volatility of all financial markets, we actually found a lot of liquidity within the green bonds that we owned in that particular portfolio, which bears this portfolio. So we were able to sell some of those bonds and buy some more attractive ones. Or we shifted some of that capital into a company like Thermo Fisher, which came to the market to fund testing kits for the pandemic. So we are able to find liquidity, and I think important for us is using our tools that I'm sure we talk about, alpha and all those within fixed income. Those are important tools that we need to make sure we have good liquidity and can get a financial return and a societal benefit.
09:15 - 09:31
So since we focus on those three other areas of exposures, maybe just give a brief explanation from how green bonds, social bonds and sustainable bonds are different. I know there might be some overlap, but I think it's useful for us to always have the definitions there is.
09:31 - 10:04
When you think about the green, social, and sustainable, they're all hitting different targets, right, in terms of what they're trying to affect with the use of the proceeds that they're raising. So a green bond is very much a project base. So it's a company that looks around in their portfolio and says, Okay, I'm going to fund a new solar field for my cloud computing warehouse and I'm going to fund that using a green bond. So it's very much a linkage to a project of what we are. And they're very green, and they can range from solar fields to pipes and water to just straight up utilities using it for other sources.
10:04 - 10:50
Then you move on to social bonds. And for me, when I think about social bonds, I think about healthcare and education. Those are the primary areas where people are kind of using that to affect it. I'll give you a great example, which I think explains social bonds very well. Bank of America. Large lender in the US, has a lot of clients. In April, during the pandemic, they issued a social bond that focused on two things, one, health care. They were using it to fund the hospitals that they already banked to support them and give them more capital as they needed more PPE and to address the pandemic. The second was small and medium size enterprise lending, so restaurants, small mom and pop stores that they were funding within that. So, see, very targeted in terms of what they were doing.
10:50 - 11:21
And the last is sustainability. That, I would say, is kind of where they throw a little bit of everything at you in a box. So there'll be a green component, there'll be a social component and overall. But really, what I think about sustainability linked bonds, I look at the overall company, what is their sustainability plan and how does this incorporate into that example of that type of bond would be alpha that they've issued one in the recent years. They're focused on a couple of things one, some green projects for their headquarters and around the world that they were trying to focus on.
11:21 - 11:53
Second part that was very important was on diversity. So funding Black-owned startups and really kind of using that as venture capital almost to fund that. But also a part of that was hiring Black and brown programmers and getting more diversity within their own firm. You know, those are two very underserved communities, and Google is as big as they get out there in terms of, we have to do that. So that's how we think about it. When you think about, when we start talking about these different things, it's all about the intentionality of the bond and what are the projects they're trying to fund.
11:53 - 12:05
Thank you. That's really helpful. And it's good to hear that Alphabet and some of the other technology companies are really focusing on, you know, diversity, equity and inclusion, which we know has been a challenge for them over the years.
12:05 - 12:38
So let's talk a little bit about risk because we've talked about some of the corporate bonds and the green social sustainability bonds. To me, that sounds like a lot of credit exposure, and a lot of clients think about the role that a portfolio like sustainable intermediate duration bond could play in their portfolio, as, you know, being a replacement for a core bond strategy. So how do you manage risk? How do you put those two things together, right? This focus on positive ESG outcomes, but also, you know, a core bond solution that can help play the risk mitigating role in someone's portfolio?
12:38 - 13:09
Yeah, I do very much believe that this can be part of a core fixed income portfolio. And what do we do? We look at the risks that we have from the credit in the portfolio, and that will vary over time, depending on our view of the markets and where we are in the economic cycle. And do that and look at that. And what we do is we take these Treasury ETFs and use that duration as a kind of counterbalance to that risk. So that can be dialed up and dialed down depending on where we are in the overall portfolio and blending those two together.
13:10 - 13:44
Now what's nice is those two assets, our credit and Treasuries, for the long history are negatively correlated assets. So as one does well, the other will do poorly and vice versa. So you do have that nice balance of that within the overall structure of the portfolio and what will drive that ETF and the amount of duration we have in the portfolio is again, where is that credit risk in the portfolio? Do we have more than we normally would have in the cycle at the time? Do we want to add a little bit more risk? So it's something we're very actively look at on a daily basis to our overall risk in the portfolio.
13:44 - 14:01
That's really interesting, and I think that is an innovative way to approach it, focusing on getting the positive societal outcomes. But it needs to be a core portfolio. So you use the Treasuries to help manage that risk, the duration and credit quality and all of those things can be tweaked by actively managing that Treasury exposure.
14:01 - 14:37
Yeah, and that's very important because these are still fixed income instruments. There's still duration effects, there are still credit rating and all that that have to be balanced with those societal benefits that you're getting. Now, longer term, you know, those are good balance and the societal benefit will outweigh, you know, over time, those benefits. But you're still subject to 10-year Treasury falling from 150 to 130. That's still going to affect credit. So you need to be aware of that in terms of the overall market for fixed income and where our view on credit spreads, rates, yield curve, all of those things are still incorporated and important in managing that risk.
14:37 - 14:50
If you think about engagement, we're very used to talking about the importance of engagement as managers of equity portfolios, right? You have an equity stake, you have a voice. How effective is engagement in fixed income markets?
14:50 - 15:42
I think it's effective, but there is this whole idea of owners versus lenders. The bond... we're lenders to a company, and then the equity is the owner. We engage with all of our companies for financial reasons, but also on what is their sustainability plan. How are they addressing net zero? Things like that. And we do that either through myself or our analyst. But what's important with AB is having this equity side of our business, that we can actually go across with a portfolio manager or the equity analyst and engage on ESG type of subjects. The financials may be a little bit different because we're looking for different things. But in terms of the ESG, good governance shouldn't make a difference between whether you're managing a fixed income portfolio or an equity portfolio. How you're addressing climate change on the E should be the same. We use that quite often with our analysts and going across.
15:42 - 16:33
I know I've done several different engagements with Dan Roarty on the equity... from our thematic equity side. We've met with, as examples, Island, which is a water utility. I think some in the audience might know that from Dan's equity portfolio, but importantly for us, we in that engagement find out they have a line of credit, which most companies do with a bank that actually has sustainable targets on it in terms of the cost to the company. And I think that was an important piece of information for me, and I came to Xylem and said, Well, why don't you turn that out into the market and use a green or sustainable bond to do that? They actually did it, but six months later. So there are ways to engage with companies back and forth. But I think for us also being a leader at a b of fixed income in general, we carry a lot of credit with the issuers that are coming to market overall.
16:33 - 16:45
You know, I hadn't really appreciated until you mentioned the benefit of having the ability for the fixed income teams and the equity teams to go out and engage together, right? And how that might improve the effectiveness of that engagement.
16:45 - 17:17
That's important part. And I think also from our responsible investing team and myself working with our analysts of what are the key things. Education, because this is a journey for all of us in terms of ESG, I have been doing it longer than most within fixed income, so I do tend to educate. But what are the key things you want to talk about with a company in a certain industry as you're engaging with them? What is their transition and what is their plan? What does that look like going forward? So that education part from our perspective in Columbia is going to be a huge part of that for our investors.
17:17 - 17:37
Well, anybody who regularly listens to the podcast know that I almost always ask about measurement, so you probably anticipate it if you listen to some of the past episodes that I would ask about measurement. So, Sean, what are some of the key metrics to sustainable or ESG success for the sustainable bond strategies?
17:37 - 18:08
I think first is always financial. What is the return regiment for the client in terms of what that is? The second part for measurement for us, we look at SDG alignment: what part of our portfolio from a revenue perspective of the companies that we invest in are aligned to specific SDGs and we can do that. We carbon footprint the portfolio. So look at what is our greenhouse gas emissions of what we own in the portfolio. Relative to a broad benchmark of the credit markets, we tend to be smaller carbon footprint than overall.
18:08 - 18:43
I'll go back also to I think one good thing from a measurement perspective is when you issue a green bond on an annual basis, you have to update data on what you affected. If You're doing a green project. When you put in solar fields, you've avoided X amount of greenhouse gases or you reduce your greenhouse gas emissions by X times over this one year. So we do look at that in terms of reporting in terms of going directly to the green bars, looking directly to the capital that we're using in the portfolio and how does that measure into change going forward?
18:43 - 19:32
Other examples is we invest in [reap] green bonds. And so we can maybe look at LEED certifications. That's a strategy that companies get rated by their energy efficiency. How many have moved up, you know, how many square feet or LEED Platinum or LEED Gold, the two highest mark. So there are a lot of different strategies and a lot of different measurements that we use. I will say that is evolving, and I think what's good for us is, as we engage with companies, we talk about what we need from an information perspective, whether it's climate information, DNI information, things, diversity, inclusion, things of that nature.. And we're trying to get that out overall. But I think, Travis, you'll see us and we'll look for you and clients that are listening to say, what are the key metrics for you? You know, this has to be interactive. What are you interested in knowing about?
19:32 - 20:24
OK, so I'm going to bring us back around to where we started. People have historically been much more focused on ESG and sustainability in their equity portfolios than in their fixed income part of their portfolios. So if someone is considering making the transition to an ESG or sustainable bond service for themselves or commonly we get asked by foundations or endowments where they have volunteer boards, volunteer committees, who have a fiduciary responsibility, but they're really interested because of the mission of the organization and doing more around ESG and sustainability. How do they do that? So I'm going to ask you, what are the key questions that these people, either individuals or these fiduciaries on boards and foundations, what should they be asking before moving forward with a transition from a traditional bond service to an ESG or sustainable bond service?
20:24 - 21:03
I think you look at the framework that someone is using to build a portfolio. For us it's UN sustainable development goals. Others use different things in terms of the framework they build. But understanding how do you get that societal benefit in your process, I think is important overall. And so understanding the framework that they're using is very important. And then the idea on the fiduciary, I think this comes up quite a bit in my conversations with people. I don't want to give up financial return. Am I doing derelict in my duties when I look at ESG or SRI investing? We've been doing this all along in terms of, I mean, we're doing good, and I say this from a fixed income side credit analysis.
21:03 - 21:34
We are always looking at these transitions that is going there. Our company is a good steward of the capital you give them. Are they good stewards of the employees that they have? This has always been. We just separate it out now into little pieces, and you have better data to understand what you're looking at. But it's always been a fiduciary and a part of what you're doing, and you can get very strong financial returns. You're not giving up anything. I think where people make the mistake when they think about us, right, is more of exclusion. So I'm going to make this easy. I just don't want to buy this stuff.
21:34 - 21:58
Well, if you really want to affect change going forward, you're going to have to invest in some of that bad stuff, whether that's an oil company in transition, whether it's steel or cement, which are heavy polluters right now. We still need steel and cement for our infrastructure. So if I can be engaged with these companies and be part of and proactive, I think you can make a stronger societal benefit going forward than just saying, I don't want to own those things.
21:59 - 22:12
Sean, thank you very much. I learn something as always when we have our conversations. I appreciate you joining the podcast and hopefully I'll have you back again. As you said, this will continue to evolve over time, so hopefully you'll be willing to come back.
22:12 - 22:15
I'd be absolutely delighted to come back. Travis, thank you.
22:17 - 22:35
This has been On Purpose. Thanks for joining us. And remember, we all have values we hold dear. Now you can ensure your investments reflect them. You can reach me on LinkedIn. If you enjoyed the podcast, please rate us on Apple podcasts, Spotify, or your podcast service of choice and be sure to subscribe. Thank you again.
- Travis Allen
- Managing Director