Sustainability-linked bonds are generating huge interest from many different institutional investors as a product that fits most investment strategies, and investors are undeterred by its complexity, according to a survey by Natixis.
Some 88% of the 40 global investors managing US$20bn of assets surveyed by the French bank said that they are either considering investing in SLBs – or are already doing so.
This rises to 94% among investors specialising in ESG, but SLBs are also attracting high interest from broader fixed-income funds (89% considering buying SLBs), as well as dedicated green bond funds (80%), primarily as a way to finance the energy transition.
SLBs are seen as suitable investments for green and sustainable funds (77%), ESG integration strategies (66%), SRI funds (49%) and conventional funds (40%) as interest and awareness grows beyond ESG specialists.
“A growing number of investors are considering or already investing in sustainability-linked bonds via their conventional portfolios, but also their ESG filtered portfolios, and that product can also be a side allocation in a dedicated green bond fund,” said Thomas Girard, head of green and sustainable syndicate at Natixis.
Most of the funds surveyed are using forward-looking SLBs as a new engagement tool to assess companies’ future performance and test the reliability of their ESG performance targets, the survey said.
The risk of greenwashing tops the list of worries about the new instrument (56%) followed by a lack of ambition (40%) as companies continue to set their own targets, and a lack of comparability (40%), while 28% of those surveyed said they were concerned by the overall complexity of the instrument.
The SLB market has attracted interest from public investors in investment-grade benchmark bonds to-date, but private interest is also growing as the product pushes into the less liquid midcap and SME space.
French investors such as Allianz Global Investors France and Amundi, and to a lesser extent Aviva Investors France and AXA Investment Managers, are showing increasing interest in products such as euro private placements.
“The SLB market is gaining interest both from public and private debt investors,” Girard said.
KPI structures
Investors prefer the key performance indicators against which performance is judged to be driven by sustainability rather than financial considerations, but expect simple and ambitious KPIs and so-called sustainability performance targets.
Energy transition and climate strategies are generating the most interest for SLBs, including water, waste and pollution as well as biodiversity, but there is a growing interest in social themes, headed by health and safety.
Of the investors surveyed, 38% said deals need two or more KPIs, while 38% said they should be determined on a case-by-case basis, and 24% preferred a sole KPI.
More than half (51%) said that SPTs should align with benchmarks such as the Paris Agreement treaty on climate change, while others said they should tally with historical performance and peer comparison, and align with ICMA’s sustainability-linked bond principles. External ESG ratings are considered less relevant.
"The combinations of structuring are endless with this type of bond. It can be quite straightforward if we have similar KPIs, trajectories and SPTs that adjust depending on sector or company. However, it can be very complex if you're mixing KPIs and targets and different time horizons," Girard said.
With a wide range of structuring options, most investors (88%) see coupon step-ups as a preferred or acceptable option, along with a premium at maturity (65%). Interestingly, more than half of investors surveyed (61%) said that they would accept a coupon step-up or (more controversially) a step-down.
Other structures were less popular, including a put option (44%), along with absolute penalties reinvested internally (35%) and externally (32%). A higher number of investors (41%) saw internal or external reinvestment as irrelevant.