Expanding impact through the public bond markets

Tapping public bond markets, and embracing a broad universe of investments beyond green bonds, can help insurers deliver on their impact-investing goals.

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As very long-term investors, insurance companies have a clear incentive to invest in areas that will benefit both the asset and the liability sides of their balance sheets. Life insurers (given their holdings of long-dated assets) and non-life insurers (with their exposure to losses from catastrophe events) are increasingly seeking to make impact investments in companies which actively combat climate change, as well as other environmental and social challenges. Unsurprisingly, there is a growing expectation from insurers that asset managers will partner with them on such initiatives (see sidebar). Exclusionary investing ― screening out coal companies, for example ― will not be enough to protect either portfolios or the environment.

Applying science to climate risk assessment

Wellington and Woods Hole Research Center ("WHRC"), the world's leading independent climate research institute, announced a collaborative initiative to integrate climate science and asset management in September 2018. This new alliance will focus on creating quantitative models to help analyse and better understand how and where climate change may impact global capital markets. Wellington and WHRC will collaborate on a broad range of projects, including developing investor tools and innovative analytical methods seeking to improve climate risk assessment and investment outcomes. WHRC will also publish academic papers that draw from the climate modelling involved in the project. Insurers are, of course, on the front line of this critical issue.

More specifically, we are working with WHRC to develop global maps with substantial granularity that model expected changes in six key physical climate variables in the coming decades. We then overlay capital market data series onto these maps, which will help us identify specific regions that warrant further fundamental research by investors across asset classes. We believe that this will enable us to better mitigate the physical risks of climate change within our client portfolios over the long term. This research may also uncover additional impact investment opportunities by identifying regions that would especially benefit from investments in climate adaptation and the companies whose businesses are well positioned to help these vulnerable regions to adapt.

Regulators, such as the PRA and The European Commission, are reinforcing this trend. They are likely to impose stress testing and require insurers to demonstrate how this analysis is embedded in their enterprise risk processes. So far, they have not provided specific regulatory capital relief for impact investments. However, they have discussed not just reducing the charge on positive impact investments, but actually increasing the charge on investments that harm the environment or society, such as entities causing pollution or engaging in human rights violations.

Against this backdrop, large insurers around the globe have committed to allocate a substantial volume of capital to impact investing. Yet they have found it difficult to source sufficient investments that qualify as impact to meet these targets. This is where the shift towards public impact investments is key given the scale of these markets. At present, many impact debt solutions focus on private markets; public markets not only widen the opportunity set, but may also be more accessible for some insurers for business and regulatory reasons.

Expanding the impact investing universe

Specifically within fixed income, we believe the opportunity set can be expanded even more by embracing a broad universe of potential investments that goes far beyond green bonds. Wellington's Global Impact Bond approach considers securities which do not necessarily have an impact label but still provide capital to entities whose core activities have a positive social or environmental impact, whether they are public companies, governments, municipalities or securitised issuers.

To be included in our universe, an issue or issuer must meet a high bar. First, most of the issuer's business activities or the bond's proceeds should address a major social or environmental challenge that aligns with one our impact themes. Second, the issuer's activities should fill unmet needs that are not easily addressed by other entities — impact investors refer to this requirement as the 'additionality test'. Lastly, the impact that the issuer is having should be objectively quantifiable.

Examples of investments we consider include mortgage-backed securities that finance low-income housing, corporate bonds issued by companies providing water and sewage services to underserved areas and municipal bonds that fund school building projects in lower income areas.

For green bonds, which currently represent only a small proportion of the portfolio, we seek to analyse not only the bond's use of proceeds, but also the overall business activities of the issuer.

Measuring impact

Identifying and reporting on suitable key performance indicators (KPIs) can be difficult, as most issuers have not previously had to produce impact metrics. Yet we believe that better measurement will lead to greater impact and increased investor confidence, creating a virtuous cycle.

So, for each bond we buy, we aim to measure and report on the overall impact. That might be the amount of CO2 and methane emissions avoided by recycling waste instead of sending it to landfills, the percentage of a population provided with clean water that previously did not have access to water and sanitation services, or the costs people save by getting basic health care from a vertically integrated provider.

Conclusion

We believe that a well-constructed portfolio of impact bonds can help insurers address the social and environmental risks in their portfolios, while also helping to satisfy ever-growing regulatory requirements. Such a liquid, high-quality core impact exposure can potentially outperform the global fixed income markets by investing in the debt of entities addressing the world's major social and environmental challenges, where we see massive structural demand for solutions.

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RISKS

There is no guarantee an investment strategy will be successful. Investing involves risk, and an investment could lose money. Before investing, all investors should consider the risks that may affect their capital.

Disclaimer:

This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investing involves risk and an investment may lose value. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed are those of the author(s), are based on available information and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.