Impact Bonds: Finding The Pieces To The Puzzle

By Gregory Simcik, CFA, Director Credit Research, Fixed-Income Investments and Samer Saleh, Senior Manager, Trading

In our roles, managing fixed-income portfolios for the Pension Boards and its affiliates, we often get asked how we choose the impact bonds that we manage on behalf of our members. Probably the best explanation is that it’s like finding pieces to a puzzle.

But First, What Is an Impact Bond?

An impact bond is a way of funding projects with environmental and/or social benefits. The proceeds raised from bond investors finances or refinances these projects. The organizations issuing the bonds often follow recognized impact bond standards and engage reputable third parties to verify that their impact bond programs comply with these standards. Impact bonds are often labelled to better categorize the projects that they fund.

For example, an impact bond may be labelled “green” if it promotes climate friendly projects, “social” if it promotes projects with social benefits, and “sustainable” if it promotes projects with both climate and social benefits. As the impact bond market evolves, other labels are being created including “blue” for projects that benefit marine environments in particular.

A Puzzle Analogy

Now, imagine you are assembling a typical tabletop picture puzzle. The individual pieces really aren’t much to look at, but they complement each other and when combined they create a work of art. Managing a fixed-income portfolio is similar. The individual bonds within the portfolio complement each other in special ways to create something more than just a collection of bonds. 

Building the Portfolio: Risk and Return Management

Some of this added value centers on better risk management, which is important for fixed income that is presented as a lower risk investment alternative. Risk measures for fixed income include duration, trading liquidity, price transparency, credit quality, geographic exposure, different registrations, industry concentration, issuer concentration, collateral, and capital structure seniority just to name a few! By carefully selecting individual bonds that complement each other on many of these risk measures, we can create a portfolio whose overall risk measures are within acceptable targets and tolerances.

Some of this added value centers on better investment return management. There are some bonds that offer higher price appreciation potential due to their nature, including bonds with call provisions and change of control covenants, while other bonds offer better coupon income (fixed interest rate) opportunities by their nature. Combining these different types of bonds creates a portfolio whose investment return is not overly dependent on just one source.

Impact Bonds Align with Member Values

Impact bonds complement the other bonds in our portfolios for better risk management and investment return management as discussed above. But the impact bonds complement each other as puzzle pieces in yet another work of art: the myriad green, social, and sustainable projects funded by the bond proceeds. In choosing impact bonds, we strive to address the many values and causes that our members find close to their hearts and their ministries.

For example, we have impact bonds that address:

·       lower carbon emissions

·       affordable housing

·       healthcare

·       gender and racial justice

·       opportunities for lower income and marginalized communities

The daily puzzle solving in our roles as fixed income managers is a blessing for us. Every day is a stimulating intellectual challenge. How many people get to say that they solve puzzles for a living!