Hats off to those who want to change the world when investing their money. The irony, however, is that the most popular way to do it — owning relatively more shares in public companies that do relatively more good — does not change much at all. If you want to encourage better behaviour by investing in listed securities, you should invest in green bonds — preferably in emerging markets.
To understand why, think about how capital markets work from first principles. Companies raise money by issuing stocks and bonds. These then trade on what is known as the secondary market — the Hang Seng Index, say. Once raised, equity capital is permanent, although it can also be cancelled. Bonds, meanwhile, have a finite life by design.
Most of the time when we say we are going to invest in stocks or corporate bonds what we really mean is that we are going to buy them in the secondary market. We are not investing in the sense of giving a company our cash. The equity or credit has already been issued and whatever happens next is between the buyer and the seller. You don’t invest in Honda when you buy a used Civic.
Thus, it neither rewards nor punishes corporate behaviour whether investors own or exclude shares and bonds in their portfolios. Often people say “If everyone sells, that will show them”, perhaps referring to tobacco or oil companies. Not true. When you sell a stock or bond someone has to buy it from you. There are just as many securities held as before.
So every exclusion policy is matched by an inclusion. Likewise, if you’re deliberately buying an ethical security you’re forcing someone else to sell. (How ethical is that?) And it is not really investing at all, it is just trading. Of course, equity holders can vote their shares and some campaigns are successful. But companies are seldom hit where it hurts — on their bottom lines.
True investing happens when stocks and bonds are issued. And this is when maximum leverage can be applied. During capital rounds companies and their advisers literally beg for cash. They listen to feedback, adapt strategies and make promises. If you want to make a difference, the primary markets are the way to go.
Which is why bonds are preferable to equities for impact investing: the primary market is easier to access. During 2019, the worldwide total issuance of new equity amounted to less than 1 per cent of the value of shares outstanding, which is nothing. No wonder most initial public offerings are so oversubscribed.
By contrast, roughly 10 per cent of the value of developed non-financial corporate bonds was issued last year, according to OECD data. And in emerging markets, including China, $600bn of bonds were sold versus $3tn of bonds outstanding — a fifth of the total. The reality is that getting a seat at the primary table when companies issue bonds is easiest in the emerging world.
That is when you can make a difference. Even better, emerging economies are most in need of the capital that investors can provide. They are poorer and disproportionally exposed to environmental, social and governance issues such as physical climate risk or a lack of sanitation, transport and health services.
Emerging green bonds are in their infancy, with a potential market less than $100bn according to our calculations. But as money is invested this capital pool will become deeper and more varied.
Still, that is plenty to be getting on with for those who want the most bang for their ethical buck right now.
The writer is global chief investment officer for fixed income at HSBC GAM
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