Why investors should be wary of “impact washing”

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February 2022
 

Whether it be green bonds, blue bonds, social bonds, or even a rhino bond, impact investing offers a remarkable and growing array of opportunities. But regardless of the opportunity, investors should be wary of “impact washing,” says Joshua Kendall, Insight Investment head of responsible investment and stewardship.

Impact investing should not be seen as a niche opportunity but as one way for institutional investors, endowments, and individuals to potentially encourage a positive environmental or social impact with their investments.

The approach is seeing increasing popularity. While there was only about US$50 billion of impact bond issuance in 2015, by 2021 annual issuance rose to around US$859 billion, compared with $534.3 billion in 2020.1

Push and pull factors have both had a role to play in this growth, which can be summarized as follows:

1. Shifting attitudes —As society and generations shift to cater for the values and priorities of so-called millennials and Generation-Z, then so too investors are increasingly seeking out companies that consider their environmental and societal impact.

2. Demonstrating commitment to achieve positive environmental and societal impacts —More and more businesses recognize the importance of supporting local communities and environments. While for corporates, multi-nationals, and sovereigns, the issuance of impact bonds can demonstrate their commitment to achieving sustainability strategies and to wider efforts such as the 2015 Paris Agreement and UN Sustainable Development Goals.

3. Regulatory pressure —In some sectors, such as utilities, regulation has threatened corporate business models, and without change some companies in sectors such as energy may face uncertain futures. For example, commitments to phase out coal power require replacement technologies that needs funding.

4. Ease of issuance —It is easier than ever before to come to market with an impact bond. There is more advice and support for issuers (from bodies such as the International Capital Market Association) and investors are increasingly asking for impact investments.

To date, green bonds, which fund projects that foster a net-zero emissions economy, protect the environment, or improve resilience and adaptation to climate change, have dominated the impact bond market. Green bonds kicked off the impact bond market in 2007 when the European Investment Bank issued its inaugural impact-based issuance. However, over the last five years, issuance of social and sustainable bonds appears to be rapidly catching up.

Charts are provided for illustrative purposes and are not indicative of the past or future performance of any BNY Mellon product.

Social bonds fund projects that aim to address or mitigate a specific social issue or seek to achieve positive social outcomes. They often target essential services such as health care, education, financial services, affordable housing, and basic infrastructure, such as sanitation, transport, and clean drinking water. Over the past year, social bonds also have been issued to help fund COVID-19 medical response activity, such as research and development, and to support welfare responses. The third major category of impact bonds fund a combination of green and social projects and are dubbed “sustainable bonds.”

Smaller markets include “blue bonds,” which focus on marine and ocean-based projects, “gender bonds,” which strive for gender equality and opportunities, and “transition bonds,” which help companies of all types support the transition to a low-carbon economy. In 2021, the World Bank launched “rhino bonds,” with US$45 million of issuance, for which investors’ rate of return will depend upon the success of raising the numbers of black rhinos in the wild.

Impact washing

While the growth and acceptance of impact bonds is generally seen as a force for good, investors must beware of what they are buying. Standards of disclosure can be lax, and this is a significant enabler of “impact washing”—whereby an issuer claims to be impact-focused but has potentially little or superficial demonstration of positive impact.

This, in turn, creates challenges around comparability in the issuance of, and reporting on, so-called impact bonds. Likewise, a lack of consistent reporting renders it difficult for investors to identify whether bond proceeds are used as initially marketed or are simply impact in-name-only.

The International Capital Market Association (ICMA) has attempted to address this with a set of voluntary principles. ICMA's Green Bond Principles set standards of transparency and disclosure with the stated intention of helping to promote "integrity in the development of the green bond market." Its Social Bond Principles and its Sustainability-Linked Bond Principles have similar aims.

The growth of the impact bond market gives more choice for investors who seek to address challenges around climate change and inequalities. However, the efficacy and validity of each impact bond varies and investors should always have robust processes in place to analyze each issue to help them choose wisely.

1 Reuters, “Global issuance of sustainable bonds hits record in 2021,” December 2021.

 

All investments involve some level of risk, including loss of principal. Certain investments have specific or unique risks.

Impact investing and/or environmental, social, and governance (ESG) managers may take into consideration factors beyond traditional financial information to select securities, which could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. Further, ESG strategies may rely on certain values-based criteria to eliminate exposures found in similar strategies or broad market benchmarks, which could also result in relative investment performance deviating.

Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.

This material has been provided for informational purposes only and should not be construed as tax advice, investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change.

This information contains projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Investment advisory services in North America are provided by Insight North America LLC, a registered investment adviser and regulated by the U.S. Securities and Exchange Commission (SEC). Insight North America LLC is associated with other global investment managers that also (individually and collectively) use the corporate brand Insight Investment and may be referred to as “Insight” or “Insight Investment.”

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