Unlocking sustainable investing opportunities in Asian fixed income

• The shift in consensus thinking in regard to fiscal spending post-COVID-19 has created an opportunity for policymakers in Asia to incorporate ESG goals into their stimulus plans. 
• The path toward a more sustainable Asia will require a huge amount of investment, and private capital plays an important role here; the region’s growing renewable sector and sustainable bond market could spell opportunities for investors.
• Sustainable investing isn’t straightforward: Most ESG issues are geographic and culturally specific—we identify factors that could influence investment outcomes.

2020 was full of surprises—not all of them positive. But the final few months of the year brought about developments that few could have anticipated: China announced its intention to achieve carbon neutrality by 2060,¹ while South Korea, Japan, and Hong Kong pledged to do the same by 2050.²

The seemingly independent announcements are highly significant. These four economies have effectively committed to removing approximately 35%³ of global carbon emissions by 2060, thereby establishing a concrete goal against which they’ll be measured. In a separate development that’s also highly noteworthy, several banks pledged to stop extending loans to finance new coal projects—and more are expected to adopt a similar approach in the coming months.⁴ In our view, these announcements reflect the continent’s commitment to address sustainability issues, which has important implications for Asian fixed-income investors.

COVID-19 has shifted consensus thinking around fiscal spending, enabling policymakers to introduce stimulus packages in a way that would’ve been unthinkable previously. This has created an opportunity for the region’s leaders to incorporate sustainability goals into their spending plans. South Korea, for instance, launched its Green New Deal in July, pledging to invest more than US$60 billion to shift its economy to a more sustainable path.⁵ While few Asian economies have followed South Korea’s lead so far, it’s likely that we’ll see sustainable initiative announcements—at the country level and/or regional level—in the run-up to the next United Nations Climate Change Conference in November.

“In our view, however, the gap between where we are today and the pledged goals is precisely where the investment opportunities lie.”

Undeniably, there’s a fair amount of skepticism surrounding these headline-grabbing pledges. Achieving these goals will require a great deal of determination and planning on the part of the region’s policymakers—not to mention an enormous amount of funding. In our view, however, the gap between where we are today and the pledged goals is precisely where the investment opportunities lie. For these objectives to be met, fundamental changes in society will need to take place: from the way energy is generated, stored, and consumed, to the way food is produced, and the way we commute—the list goes on. These changes present investors with an opportunity to participate in the continent’s path toward creating a sustainable future.

Renewables

As Asia continues to grow, its need for energy rises—the region is forecast to account for nearly two-thirds of the world’s new power demands in the next 20 years, with China and India leading the charge.⁶ It’s no mere coincidence that these two economies are dominating the global renewable energy market.

China supplies more than 70% of the world’s solar panels and has recently pledged to invest as much as US$6 trillion toward the development of new energy technology by the end of the decade.⁷ The country’s recent carbon neutrality pledge means its existing targets and policies will need to be revised higher in order to achieve its goal. India, on the other hand, plans to install 100 gigawatts of solar power capacity by 2022 (up from about 35 gigawatts in 2020⁸), having managed to generate solar energy in a manner that’s cheaper than coal.⁹ We believe this segment will create many entry points for fixed-income investors.  

Electric vehicles

Electric vehicles (EVs) is another area in which opportunities emerge for the sustainability-minded investor. EVs have taken on an increasingly important role in many national decarbonization plans. As consumers in Asia begin to transition from gas-powered vehicles to EVs en masse, demand for lithium ion batteries—which power these vehicles—will also rise. This expected development is set to play to China’s strength, given its status as a world leader in this area. The Indian government, meanwhile, is looking to shore up its battery manufacturing capacity, having introduced various policies to incentivize manufacturers to start producing lithium ion cells in the country.¹⁰ Neighboring Asian economies, which are likely to be part of the regional supply chain, could also benefit.

Sustainable bonds

The rise of sustainable financing—in which proceeds are used exclusively to fund projects that bring about environment and/or social benefits—has been well documented. Green bonds, in particular, found favor with many investors, having hit an important milestone in September 2020 by crossing the US$1 trillion issuance mark globally since their introduction in 2007.¹¹

Green bonds: the US$1 trillion milestone

China has historically been an active green bond issuer. In the first three quarters of 2020, the country issued US$9 billion in green bonds and remained the top issuer in the Asia-Pacific region last year. Singapore, Japan, and South Korea also made the list of the most active issuers globally during the nine-month period—evidence of the instrument’s growing popularity in the region.¹²

Crucially, we noticed that the green bond structure has drawn the attention of Asian credit issuers from other sectors in recent years beyond the traditional realm of energy and infrastructure. Real estate developers and real estate investment trusts in China, Singapore, and the Philippines, for instance, are beginning to tap into this market for funding. In our view, this pairing makes sense as tenants and buyers are increasingly environmentally conscious and prefer energy-efficient structures with low-carbon footprints. This is an encouraging development since it reflects the growth in both the breadth and depth of the region’s green bond market, which should, by extension, usher in new opportunities. 

Global social bonds issuance surges in 2020

Until recently, knowledge of social bonds was mostly restricted to sustainability practitioners and the investment community; however, the COVID-19 outbreak changed all that. Social bond issuance globally in 2020 soared to more than US$160.0 billion, up from US$13.3 billion a year ago.¹³ The rationale behind the surge is obvious: Issuers—which include sovereigns, supranationals, and financial institutions—saw it as a means to help mitigate the socioeconomic impact of the pandemic.

Given widespread acceptance of the need to invest more in public welfare and address issues such as income and gender inequality, it’s easy to see why social bonds are likely to remain high on the agenda for both issuers and investors. This could be particularly relevant to emerging Asia—where social bonds are being used to finance social development projects. Although growing from a smaller base, issuance in the region last year more than tripled to over US$20.0 billion from US$6.4 billion in 2019.¹¹

Transition bonds

Weaning the world off fossil fuel takes time; it isn’t something that could happen in an instant: Relevant infrastructure needs to be built, funding needs to be procured, and plans need to be devised to address the issue of stranded assets. This is where transition bonds come in—debt instruments that could help fossil fuel companies and other heavy CO₂ emitters fund their clean energy transformation.

Understandably, transition bonds (also known as brown bonds in the color-coded world of sustainable investing) have ignited a fair amount of debate. Critics fear these instruments could provide polluting companies with an easy way to hide behind their—as-yet unearned—green credentials. These concerns are no doubt valid, and active scrutiny can only be healthy; however, we believe that transition bonds, when used appropriately and tied to strict targets, can be an effective way of steering polluting firms onto a more sustainable path. The idea of funding a transition is likely to resonate in Asia since the region is, after all, home to many emerging economies that rely on dirty energy and need to rapidly decarbonize. It isn’t unthinkable that transition bonds—which are still in their nascent stage of development—could eventually play an important role in the region’s sustainability journey. It’s certainly an area that warrants close monitoring.  

Governance

Forty-three percent of the world’s top 5,000 companies, according to total revenue, are headquartered in Asia¹⁴—it’s a staggering data point that speaks to the region’s growing economic prowess. The inherent contradiction here is that Asian companies typically feature in the lower tier of most global corporate governance rankings. The positive correlation between profitability and good corporate governance practices is well known, and there can be no doubt that the region’s companies have much work to do here. The less obvious takeaway, we’d argue, is that when viewed through the lens of sustainable investing, independent and diverse governance structures can be an important investment theme that can be a meaningful source of alpha. 

It’s easy to understand the appeal of sustainable investing—it’s that rare positive investment story that enables investors to participate in building a more sustainable future while generating meaningful returns; however, it would be disingenuous to pretend that challenges don’t exist.

The absence of a common taxonomy means that data vendors, environmental, social, and governance (ESG) research providers, and issuers can have varying definitions of key metrics, making analysis a highly challenging task. Similarly, ESG rating companies aren’t regulated in the same way as credit rating agencies, calling into question the reliability and accuracy of their work (a popular charge relates to greenwashing and, increasingly, social washing).

We’d go a step further and argue that going active is merely a starting point—a comprehensive, well-thought-out approach is required for any endeavor to be meaningful.

For these reasons, many have noted that sustainable investing is best suited to active management. However, we’d go a step further and argue that going active is merely a starting point—a comprehensive, well-thought-out approach is required for any endeavor to be meaningful. This is particularly important with reference to Asia where its economies—and by extension, its fixed-income markets—are anything but homogenous. What follows are some of the steps that we’ve taken at Manulife Investment Management that we believe are important when it comes to sustainable investing in this asset class. 

Access to a dedicated team of ESG specialists

Fixed-income investing and ESG research are two separate disciplines, and it’s important that both teams are able to work together to create an integrated investment process that takes into consideration all relevant ESG factors. However, the collaboration between both teams doesn’t end there—post-integration monitoring is just as important. In our view, having access to a dedicated, well-resourced team of ESG specialists is a prerequisite to investment success in the Asian sustainable fixed-income space.

Local presence is critical

It’s an inescapable fact: Most sustainability issues are geographically and culturally specific. In a sense, this is reflected in the diverse nature of the various economies that make up what we call the Asian economy. Having a strong local presence is essential—it enables the investment team and the ESG specialists to keep tabs on local developments and translate idiosyncratic nuances that are often lost within a global context. In our experience, the ability to view developments through the local lens enabled us to get to the heart of the issues faster and make more considered and better investment decisions.

We rely on our team of dedicated ESG specialists not only for original insight, but also for their ability to bridge and verify ESG data from external sources.

Independent proprietary research

The shortage of external analyst coverage is a persistent issue within the Asia fixed-income universe; unsurprisingly, the issue is exacerbated in the area of sustainable investing. For this reason, the critical role that independent and proprietary research plays in the investment process couldn’t be clearer. In our case, we rely on our team of dedicated ESG specialists not only for original insight, but also for their ability to bridge and verify ESG data from external sources. Similarly, we depend on our Asian credit research team for proprietary in-depth credit analysis that isn’t readily available from global third-party researchers. The credit research team’s input provides insight into the materiality of ESG risks and enables the investment team to identify potential social/greenwashing at an earlier stage and in a more informed, objective way. 

A robust corporate engagement program

In our opinion, all investment firms that are serious about sustainable investing will have a comprehensive corporate engagement program in place. This would typically be run by the ESG team, with the goal of entering into a dialogue with investee firms to encourage them to mitigate ESG-related challenges or take advantage of opportunities. At Manulife Investment Management, we make it a point to share relevant ideas on best ESG practices with investee firms—leveraging our research in different sectors and regions—with the aim of helping them create value in their business and enhancing returns.

Opportunities in sustainable investing in Asia are growing, particularly in the fixed-income space. Recent announcements from China, Japan, South Korea, and Hong Kong have strengthened our belief that the region has indeed moved beyond the inflection point on the sustainability front. We’re confident that the year ahead will bring about more encouraging developments. However, in order to unlock the investment potential that Asian fixed income has to offer on this front, we believe the right tools must be in place. 

1 “The secret origins of China’s 40-year plan to end carbon emissions,” The Japan Times, November 23, 2020. 2 “Hong Kong Pledges Carbon Neutrality by 2050, a Decade Before the Mainland,” Caxin Global, November 26, 2020. 3 “Fossil CO₂ emissions of all world countries—2020 Report,” European Commission, September 10, 2020. 4 “More Asian banks seen avoiding coal projects,” Business Mirror, May 5, 2020. 5“South Korea’s Green New Deal shows the world what a smart economic recovery looks like,” The Conversation, September 9, 2020. 6 “Can Solar Power Compete With Coal? In India, It’s Gaining Ground,” Wall Street Journal, February 17, 2020. 7 “Promoting China’s Energy Transformation through Deepened Supply-side Structural Reform,” Development Research Center of the State Council of the People’s Republic of China, August 21, 2020. 8 “India aims for half of state-run fuel stations to be solar-powered in five years,” Reuters, September 15, 2020. 9 “India leads with lowest renewable cost in Asia-Pacific,” Wood Mackenzie, July 27, 2019. 10 “PLI scheme powers up lithium-ion cell making,” Hindustan Times, November 30, 2020. 11 “Record Month Shoots Green Bonds Past Trillion-Dollar Mark,” BloombergNEF, October 5, 2020. 12 “Green Bond Market: Summary Q3 2020,” Climate Bonds Initiative, November 13, 2020. 13 Refinitiv, as of December 17, 2020. 14 “Corporate Asia: A capital paradox,” McKinsey & Company, January 2020.