Fixed income is the biggest asset class in global financial markets and caters not only to corporates but also the sovereign, supranational and agency sector. Naturally, fixed income is an important proportion of pension and sovereign funds’ portfolios and a key consideration in the green transition.
A common thread among the funds that took part in OMFIF’s Transition Finance Working Group discussions was a view that more government policy is needed to enable the energy transition. This provided an interesting juxtaposition with funds’ engagement on corporate transition policy, where the general position was one of both engagement (almost uniformly) and investment re-allocations (more mixed). Funds generally expressed little or no transition engagement through government bond portfolios, and much more on corporate bonds.
What are the impediments for funds to engagement with such policy? Two main reasons were given. First, many of the funds have clear constraints when engaging with public (as opposed to corporate) policy, being part of public policy themselves or highly dependent upon it. A core fixed-income position for any pension or sovereign fund will be in domestic government bonds, where policy engagement simply is not feasible. Given that that core fixed-income allocation is out-of-bounds for engagement, engaging with other governments could be seen as inconsistent.
Second, the fixed-income allocation was seen as a treasury function or liquidity pool. In addition, given resource constraints – engagement is costly in terms of human capital – there are economic impediments to using the fixed-income book as a tool to drive transition.
Having said this, several of the funds were engaged in a number of collaborative policy initiatives, formally disconnected from their own security holdings, but still viable to be considered as a government policy engagement pathway.
On the corporate side, funds are clearly looking to apply transition strategies similar to the public equity class, with some arguing that private credit provides even more opportunity for engagement. The use of various forms of labelled debt, mostly green bonds, is common although not specifically for direct transition strategies. Rather, funds appear to consider transition stories at the corporate level, rather than as use-of-proceeds or asset-linked plays.
In line with this, the working group funds were generally positive about the concept of linking transition performance targets to coupon variations in bonds. However, one fund expressed very clear scepticism of the sustainability-linked bond market in its original form, as well as the dearth of performance-linked structures in the government bond space. This raised questions about the viability of transition-linked bonds that ask for outcomes, but are not prescriptive in terms of the policy needed to get there.
Another question asked in the discussions was how time differentiation, i.e. ‘curves’, was considered in terms of transition strategy. The fact that fixed-income instruments trade at fixed maturities is important for contemplating transition: it is often defined in terms of time-frames such as net-zero 2050 targets. One could, for example, consider investing in a company at a short maturity if its short-term targets seem reasonable, but avoid longer-dated bonds if the long-term strategy is not clear. Interestingly, the majority of funds did not differentiate significantly between maturities in terms of their fixed-income books at present, suggesting room for transition strategies to evolve in this area.
Ulf Erlandsson is Founder and Chief Executive Officer, Anthropocene Fixed Income Institute.
This article featured in the working group’s first report, ‘Global public funds and transition finance‘. Ulf joined a panel of experts to discuss the key findings of the report.
