Trending - Socially Responsible Fixed-Income Investing

by: Columbia Threadneedle Investments

Summary

Until recently, ethical investing has focused on avoiding exposure to perceived negative activities.

Municipal bonds can offer a cost-effective way to fund programs and infrastructure to serve the public good.

An increasing percentage of the public is conscious of how its purchasing decisions affect the world.

By Chad Farrington, CFA and Robert McConnaughey

While it has been part of U.S. equity investing for decades, socially responsible investing is relatively new to the fixed-income space and to the municipal bond arena in particular. It is quickly evolving, however, and gaining traction as an important component in many individual and institutional ­fixed-income portfolios.

An investment philosophy that goes beyond assessing financial return and considers broader social implications dates back to when the Quakers prohibited investments in the slave trade. Similar approaches are evident in other parts of the world, with ethical factors playing an integral role in investment approaches.

Until recently, ethical investing has focused on avoiding exposure to perceived negative activities. Ethical investors direct capital away from companies involved in industries such as tobacco, ­firearms and other products that are viewed as detracting from the overall social good. Many investors have gone a step further by investing in companies that make positive social contributions. In its most advanced form, this practice is known as impact investing.

We believe efforts to bring societal impact into the investment decision process will continue to expand as it becomes increasingly clear that the strategy can be executed without necessarily sacri­ficing long-term ­financial returns. However, ethical investing must be approached in a balanced and disciplined manner to meet a broad range of goals.

Municipal bonds are designed to serve society

One area particularly well suited to socially responsible investing is local municipal bonds, which offer a cost-effective way to fund programs and infrastructure to serve the public good. For example, local roads, bridges and water and sewer systems are public assets essential for a functioning society. Programs such as public education can create opportunities for economic advancement, while affordable housing and health care provide support for the neediest in our society.

Municipal bond issuers, either governmental or non-pro­fit organizations, use net revenue from bond offerings to advance their missions of providing health care, maintaining roads, educating underserved populations and building affordable housing. Investors focused on balancing ­financial returns with positive societal impact could easily start with a universe of municipal investments designed to serve the public good.

We believe in the typical course of constructing a muni bond portfolio; elements of social importance can be incorporated so that investment performance is not sacri­ficed. In fact, in many cases, the more effectively and ef­ficiently a municipality applies the proceeds of an offering to advance the public good, the stronger its fundamental credit. Therefore, analyzing positive societal impact and fundamental credit are actually related exercises.

A municipal bond’s issuing documents detail how proceeds will be used and allow investors to determine the investment’s intended social impact. We begin our muni investment process by assessing the issuer’s fundamental credit strength. We review various time-tested factors to determine default risk but focus on the ­financial strength of the organization and the likelihood that it will be able to repay its debt obligations in addition to its ongoing operating expenses. If the price of the bond appropriately compensates for the risks, we will consider making an investment.

Since our investment process already includes an analysis of what the bond proceeds will be used for, it is easy to take the next step: to identify the universe of offerings that have these credit characteristics and also ful­fill socially responsible goals. Some examples of projects that we believe align closely with socially responsible values include:

> Affordable housing developments

> Charter schools that produce high graduation rates in poor communities

> Water treatment projects that prevent wastewater from polluting rivers or lakes

Again, delivering these services effectively and cost ef­ficiently is good for the credit and for the sustainability of these worthy programs.

In addition, in today’s environment of increasing tax rates and depressed yields on Treasury securities, municipal bonds provide investors with a compelling combination of tax-exempt interest income and the opportunity to fund projects with signi­ficant positive social outcomes. In the end, a dollar of tax-free income gained from such investments is a dollar that can be reinvested in additional positive impact.

Corporate bonds require diligent analysis

The much larger corporate bond market also offers opportunities for advancing socially responsible investing ambitions. However, it can be dif­ficult to determine how money raised in the corporate bond market is being put to work. We are extremely wary of the real impact of some “green bond” offerings, especially from issuers with questionable credibility when it comes to responsible corporate practices. Therefore, we believe that investors should consider an issuer ranking or screening technique combined with an analysis of speci­fic acceptable policies and practices. In our view, this approach builds on what our analysts have always focused on when analyzing investment opportunities: Credit analysis is fundamentally about the sustainability of a business.

We want to be vigilant about any threats to that sustainability, whether from competition, macroeconomic forces, environmental regulation, changing consumer preferences or declining relations with a labor force. Technology and social media have accelerated the speed at which information is spread around the world. For businesses, new tools allow for more ef­ficient marketing and delivery of better products. However, they also mean that companies must be more careful to avoid negative public opinion. For example, consumers can quickly shift buying habits away from companies that use child labor in China or run factories that pollute community water sources. Today’s consumers are acutely aware of the potential effects of issues such as climate change or practices such as genetic engineering of food. And they appear to be much more willing to alter their buying preferences away from products with negative societal effects and toward those with positive results. Therefore, it is not surprising to find that companies that are proactive and dedicated to adapting their businesses to deal with and solve these challenges are often the strongest performers in their respective industries.

Longer-term ­financial return is not necessarily diluted and may even be enhanced by focusing on companies that understand the benefits of addressing social issues. These companies have discovered a way to manage the environmental impact of their production methods and assure the respectful and inclusive treatment of their customers and staff, all within a disciplined ­financial model.

A growing trend with real potential

It is clear that an increasing percentage of the public is conscious of how its purchasing decisions affect the world. More consumers worry about sustainability and inherent fairness within society, and more investors seek bene­fits beyond pure ­financial return. This awareness is driving rapid growth of the socially responsible investment segment from a market niche to a powerful mainstream trend.

We believe this growth is commendable and likely to continue. There is real scope to bring together investment opportunities that marry attractive ­financial returns with meaningful social outcomes. It will take discipline, skill and broad resources to ensure those goals are effectively combined to deliver a win-win proposition. However, we believe that it will be well worth the effort. Doing well while doing good is a compelling outcome to pursue.

Disclosure: None

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