Sponsored article: Iain Buckle examines the way investment in short-dated corporate bonds can be kind to the environment.
Corporate and local government treasurers face many challenges, including a backdrop of negative real returns on cash which demand they consider alternative investment solutions. At the same time regulatory, societal and investment pressures are driving a greater awareness of climate-related risks, with a reported 74% of UK local authorities declaring a climate emergency.
In this article we discuss why short-dated corporate bonds which are relatively close to maturity can help investors to capture attractive yields with minimal interest-rate sensitivity, low portfolio volatility and good levels of liquidity—all while having a relatively low climate—related impact.
Appeal of short-dated investment grade bonds
The unique characteristics of short-dated bonds offer investors an opportunity to access a lower-volatility segment of the broader investment-grade fixed income market.
Short-dated investment grade bonds can be attractive to a diverse range of clients, including local authority treasurers, seeking enhanced returns above cash and local authority pension schemes undergoing de-risking.
Their appeal is based on a range of factors, including:
- A record of generating attractive risk-adjusted returns;
- Capital-preservation qualities – individual bonds are typically much more resilient to negative company-specific events than longer-dated bonds;
- They are less susceptible to fluctuating interest rates, because they derive returns through credit risk rather than duration risk;
- They can generate steady cashflows, which can be paid-out as an income or reinvested to take advantage of further opportunities;
- Short-dated bonds are inherently more liquid than their longer-dated equivalents, due to the relatively high frequency of bonds reaching maturity;
- There is no material cost to having a low carbon impact.
It is this final benefit that we want to explore in more detail.
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Assessing climate impact
It is important for fixed income managers to consider climate risks, particularly in the highest-emitting sectors such as oil & gas, utilities and transport.
However, if you look beyond the headline emission numbers, then the financial sector also carries climate risks.
There are challenges to overcome, not least the varying degrees of willingness by banks themselves to adopt aggressive targets to reduce climate exposures. The practicalities of reducing carbon intensity for a bank’s loan portfolios are also demanding and it can take many years to effect meaningful change.
As an investor we believe the best way to understand and manage these risks is through active engagement with banks and other financial institutions. This enables us to encourage more aggressive targets and help improve the quality of disclosures from large financial institutions.
Maturity and climate risks
The analysis and decisions made around climate risk can vary significantly depending on the maturity of an individual bond.
This is because some of the key climate risks in areas such as stranded assets and the costs of transition can take many years to play out.
Although we can potentially identify those risks now, they can take a long time to significantly impact a company’s credit profile. In general, the longer you lend to a company that potentially faces climate risks, the more you are exposed to those risks.
So, for holders of longer-dated bonds, especially through buy-and-hold strategies, it is vital to analyse and understand climate change risks.
If you are lending to climate-exposed companies over the longer term, then you can typically get paid a premium for doing so. But this is not true for shorter-dated bonds, which are much less exposed to a climate-related deterioration in credit quality during their lifetime.
What this means is that we can construct a short-dated investment grade credit portfolio that does not sacrifice expected return, but which has a weighted average carbon intensity of around two-thirds less than the broader universe. That is something which is potentially attractive to corporate and local authority treasurers.
Iain Buckle is an investment manager at Aegon Asset Management.
For more information about the Aegon Short Dated Investment Grade Bond Fund please contact Alex Ross on alexandra.ross@aegonam.com or visit www.aegonam.com.
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