The impact bond market has grown at a substantial pace over the past few years. With so much uncertainty in markets at present, many investors are wondering what this means for green, social and sustainable bonds. We decided to talk to CIO, Justin Eeles, on what he’s seeing in markets at the moment, and his thoughts about the future.

1. How does this recent crisis compare to others you have experienced in your career? 

I began my career at Norwich Union Investment Management – now Aviva Investors – back in 1987. Since that time, I have experienced a number of market shocks including, of course, the Great Financial Crisis (GFC) of 2008. While the cause of this crisis is different from any others I have seen in my working lifetime, it exhibits many of the same market reactions.  As in any crisis, there has been risk aversion and flight to quality. This is seen in the currency markets, for example, with ‘safe-haven’ currencies such as the US dollar appreciating, and many emerging market currencies selling off.

What is unprecedented for anyone who is working today is the swiftness and extent of the downturn. Unlike in other crises, even the US Treasury market saw liquidity stresses; this is not something I have experienced before. However, what is similarly unprecedented is the speed of the subsequent response, with both central banks and governments moving quickly and at huge scale. How these two opposing forces play out will be at the centre of our thoughts and observations.

2. What challenges have you experienced in the impact bond market during the crisis and are these challenges still present?  Are the challenges any different from the wider fixed income market? 

From my experience, liquidity has been the biggest challenge, even more so than during the GFC. One of the reasons for this is the inability of banks to act as risk-intermediators in the way that they could previously. Since the GFC, banks don’t take as many positions themselves, and the risk of what is on their balance sheet is assessed more continually and to a greater degree. The unintended consequence of this is reduced liquidity in the market in times of stress. This is not particular to the impact bond market though; it is the case throughout the wider fixed income market, including the US Treasury market.

Liquidity is now improving but does remain a challenge. Often on-screen prices are not reflective of the actual buy or sell price. We expect liquidity to slowly improve but the uncertain economic environment may mean that risk tolerance may remain reduced, affecting turnover levels in the market. We are therefore adopting a conservative approach, maintaining slightly higher cash balances in the portfolios. We are also fortunate to have experienced inflows into the portfolios during this period, which has helped.

3. Tell us about any new issuances that have come to market in March/April?

Despite bond issuance slowing, especially in February, the impact bond market has continued to expand. In fact, we are seeing similar levels of issuance being recorded compared to this time last year – a record year for impact bond issuance. Part of the reason for this is the rise in social and sustainability bonds, many of which are COVID-19 themed issues.

Our SPECTRUM criteria have allowed us to analyse COVID-19 related bonds within our usual process. Where they have met our criteria, we have been able to purchase a number of these issues in our portfolios. One of these is the African Development Bank (AfDB) ‘Fight Covid-19’ Social bond, which was issued in huge size at US$3bn. AfDB was amongst the earliest to issue a labelled COVID-19 social bond to support initiatives through a use-of-proceeds bond structure. It was the largest dollar denominated social bond to date and the largest US$ benchmark bond issued by AfDB. Other purchases include the social bond from Cassa depositi e prestiti SpA (CDP), looking to respond to the crisis in Italy, and the issue from Agence Française de Développement (AFD) to help finance the “COVID 19 – Health in Common” initiative.

Outside of the labelled bond market there have been a number of reasonably large issues to help tackle the crisis. The World Bank, for example, issued a US$8bn issue in April to assist in pandemic relief. Government-related entities have been significant borrowers in this period, with Bpifrance Financement, the French government agency, issuing a “Covid-19 Response Bond” to assist companies and reduce the social impact of the pandemic. Many of these types of issues, while pledging to use funds for relief efforts, have not used prescribed frameworks, instead preferring to come to the market quickly.

[A further discussion on COVID-19 themed bonds can be found on our website here].

4. What is AIM’s global outlook  

The economic outlook is clearly extremely uncertain because we don’t know the extent of the impact of the lockdowns, how long they will last nor how fast the rebound will be. What we do know is that there has been unprecedented fiscal and monetary support to lessen the impact, and that – in many cases – this is feeding through.

We believe that a recovery will come, possibly in the first half of 2021, but it may be several quarters before pre-virus levels are seen again. Volatility and uncertainty are expected to remain high, and liquidity problems to continue. As mentioned, we are holding portfolio cash balances somewhat higher than normal for prudential reasons.

There are likely to also be sharp distinctions within credit markets between issuers with resilient business models and those with much less ability to survive this abnormal period. Sustainability of business and policy models, and higher credit quality – which our green and sustainable bond portfolios already emphasise – should continue to do well in markets which are more risk-averse and sensitive to the distinction between good and risky credits.

5. Tell us one good aspect about working from home? 

Most simply, I am really enjoying the reduced commute, and not having to iron a shirt first thing each morning. We have a bird box in our garden, and, given the current trajectory, are likely to be able to watch the fledglings leave the nest before returning to the office.

Of course, another positive aspect is the huge environmental impact we are seeing given the lack of travel, as depicted by clear waters in Venice and the lack of smog over cities. We can only hope this appreciation for the environment continues.