Finding innovative ways to fund sustainable cities in Asia
As the determination to meet net zero goals sweeps across Asia Pacific, improving the sustainability of the region’s cities is both a critical and urgent component.
In short, cities need to respond rapidly to the dual challenges of migration and climate change. This requires a combination of measures, including: enhancing urban mobility; upgrading infrastructure; promoting integrated development; improving health and educational facilities; and investing in innovative technological solutions to support these elements.
All these efforts require significant and multiple rounds of financing. Additionally, given that the need for capital to make cities more sustainable is secular rather than a passing fad, a fixed income mindset makes sense.
“Infrastructure projects in Asia are generally capital intensive and usually require more than one round of cash injections,” said Jean-Charles Sambor, head of emerging market (EM) debt at BNPP AM. “We see this as a long-term opportunity marked by sufficient demand and, most importantly, continued growth.”
Making sustainable debt mainstream
In general, investor optimism about this segment is reflected in a steady outperformance of ESG assets over the broader indices across asset classes.
Looking at green, social and sustainability (GSS) bonds specifically in emerging markets, the IMF estimates that since 2019 – the period in which more than half of EM ESG bonds were issued – they have returned 2.8% more in terms of average annualised return than the corresponding broad index. Since the Covid-19 pandemic, this differential has eased to a still notable 1.5%.
In line with this, BNPP AM’s Sustainable Asian Cities (SAC) Bond strategy is designed to invest in a mixture of GSS instruments, as well as sustainability-linked bonds – collectively known as sustainable-labelled bonds.
The strategy also targets exposure to conventional bonds from issuers that derive at least 20% of their revenues from this theme; this is a universe the firm estimates at around $110 billion-plus in outstanding securities as of October 2021. Adding potentially eligible sustainable-labelled bonds, the total stands at more than $230 billion for the time being.
More growth is inevitable, given sustainable-labelled bonds represent one of the most sought-after parts of the fixed income landscape. Moody’s, for example, forecasts $1.35 trillion in issuance for 2022, while S&P Global Ratings expects issuance of GSS and sustainability-linked bonds to surpass $1.5 trillion this year.
In addition to volume, a peculiarity of GSS bonds is their ability to trade at a premium versus regular, or vanilla, bonds.
“We believe this investment strategy allows investors to tap into the growing ‘greenium’ (green premium) of GSS bonds in Asia,” said Sambor.
While more mature GSS bond markets such as Europe show evidence of a greenium associated with holding sustainable-labelled bonds, this is still in its early stages in Asia. But Sambor expects it to mature over time. “This will benefit early adopters who will be well-placed to harvest such premiums rather than being late to the game and missing this source of returns when green bond investing becomes the norm.”
Further fuelling the sector is the development of regional taxonomies in Asia amid efforts to standardise the information that issuers must disclose.
However, capitalising on these dynamics and attracting investors at the same time requires a sustainability strategy with some core features.
Among them is having an investment opportunity based on a local theme but with an impact on the global economy, said Sambor.
Another key element is the need for a very focused theme, he urged. “We don’t want to put another ESG fund on the shelf.”
This reflects the fact that since ESG considerations are embedded into the firm’s investment process anyway, it doesn’t see a future in offering investors yet more integrated ESG products. “Instead, we will provide solutions and products that are attractive to investors more broadly,” added Xuan Sheng Ou Yong, ESG and green bond analyst at BNPP AM.
Yet a sustainability strategy can still only be effective if anchored in strong credentials. In BNPP AM’s case, this stems from the firm’s proprietary thematic bond-assessment framework, its Responsible Business Conduct policy and its proprietary ESG scoring system.
Beyond processes, the broader macro and market environments also favour the focus on sustainable cities.
With sell off in Asia US dollar credit over the last year, BNPP AM sees Asian bonds as attractive from a valuation perspective.
Sambor describes this as an inflection point. “Asian credit, particularly in the high yield segment, has been oversold given the concerns over the Chinese property sector. We firmly believe this will be the year of the great normalisation of Asian spreads and that outsized returns are likely to be driven by Asian high yield given its attractive valuations and the potential for significant spread compression.”
At the same time, EM debt valuations look compelling now. “This is one of the few fixed income asset classes providing good entry points in the middle of the US Federal Reserve’s policy tightening cycle as spreads are high compared with other fixed income asset classes,” he explained.
Click here for more insights, including BNPP AM’s white paper, “Sustainable Asian cities – preparing now for the future”.
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