The rise of green and sustainable bonds are helping to reshape the fixed income market by allowing people to invest with a social and environmental purpose, without sacrificing their return on investment. Bill Bovingdon (Australian Ethical) examines this growing part of the market.

Fixed income plays an important role in any diversified portfolio. As an asset class, it provides a portfolio with various defensive qualities, including: relative stability in price, diversification benefits, liquidity, income and yield.

These are all important characteristics when building portfolios where regular and predictable cashflow is needed.

In making the case for fixed income, Bill Bovingdon — Investment Director at Australian Ethical — points to most major economies moving towards cash rates of between 2.5-3 per cent. And while he believes that will provide a mild tailwind for bonds, he adds that steep yield curves will persist, as inflation risk remains. “Moving forward, with more persistent inflation expected, this means higher longer term rates, regardless of whether short-term rates continue to come down.” 

However, against this backdrop, Bill believes a rapidly emerging trend within fixed income markets, particularly over the last five years, is allowing more investors to use this asset class to “invest for purpose”. This has been possible through the growth of the green and sustainable bond market.

Speaking on fixed income at the IMAP Independent Thought 2025 conference in Sydney, Bill believes green and sustainable bonds are one of the most significant developments in the market since fixed income securitisation in the 1970s.

Green and sustainable bonds effectively raise capital to fund projects with positive environmental and/or social outcomes. Green bonds specifically finance environmentally beneficial projects, while sustainable bonds have a broader scope, encompassing both environmental and social projects. Both operate similarly to traditional bonds, but the proceeds are ring fenced for their designated purposes. Bill believes while these bonds are relatively easy to understand, they are still under-appreciated by many investors.

By incorporating green and sustainable bonds within a portfolio, Bill says it provides the investor with all the characteristics and benefits of a typical fixed income allocation, while investing for purpose and without sacrificing returns.

“These bonds are a relatively new concept that enables investors to get a second benefit out of the investments they make. It’s not just about the return. It’s about providing capital for ‘social good’, with a proviso of how that capital is going to be used, and doing it without sacrificing the returns investors get from holding fixed income assets,” says Bill.

“Typically, capital is applied to some of the most important challenges we currently have globally. These include: addressing and mitigating the issues around climate change, tackling food and energy security, and creating social housing. Bonds have been issued to specifically address these types of issues.”

According to Bill, what’s important about the way this market has developed is how it has encompassed a set of features that allows for a degree of oversight and engagement that bond managers typically have never had.

“Through the agreed accreditation processes that bond issuers go through (as set out by the International Capital Market Association), there is a framework which has now become well-established in markets. A verification process through entities like the Climate Bonds Initiative, also provides a degree of certainty and confidence about the way this market operates.”

Reporting is also an important factor with green and sustainable bonds. Investor reporting enables investors to clearly see the impact their capital is having on funding these projects as they mature. Bill says engagement and reporting is an absolute necessity in this sector, because there is an expectation by investors that these bonds will deliver on their stated social and environmental objectives, while delivering a return on investment.

“You can’t do that on a passive basis,” he says. “We’ve seen the damage that greenwashing has done to the reputation of the ESG market. So, it’s essential to have proper integrity and transparency, and it’s incumbent on investors, like Australian Ethical, to maintain close engagement with issuers to ensure they actually fulfil their obligations.” 

In the current market environment, Bill believes by investing in these types of bonds, retail investors can expect to receive a higher return than a term deposit rate. For example, diversified fixed income portfolios, like the Australian Ethical Altius Green and Sustainable Bond Fund, have been delivering returns of about 5-6 per cent over the last three years (after fees), providing investors with an active return of around 75 basis points.

(An active return of around 75 basis points means the investment outperformed its benchmark by 0.75 per cent, and is an indicator that that the portfolio manager’s decisions added more value to the portfolio than a passive investment tracking the same benchmark.)

“For the funds Australian Ethical manage, our fees are very competitive. That’s because we have scale. We’re able to tap into the ESG and ethics teams that service our whole organisation, which means additional costs are not carried by one product or asset class.”