Episode Transcript
Speaker 1 00:00:08 An overwhelming majority of institutional investors say the Coronavirus outbreak is already having an impact on their investing activity. And many doubt the US government's ability to effectively combat the crisis, that's according to a new survey from Eaton Partners. They say that 70% say that coronavirus the outbreak is having an impact on their investment activity and their 2020 planning activity. So joblessness manufacturing and housing concerns and extreme market volatility. That's what we're dealing with. Now. The question is, can sustainable assets provide long-term benefits? And what will be the role of sustainable assets, specifically fixed income assets in recovery? Here to discuss this with us today is LF Linson, C I O of DM, green Credits, and today we're going to discuss the changing role of green bonds in light of the current COVID 19 crisis, the role fixed income can play in a recovery, and how investors should approach the green bonds market. Lf, thank you so much for joining. Thank
Speaker 2 00:01:14 You very much. Great to be here.
Speaker 1 00:01:17 So I'll share with us how has the current crisis changed the way that we look at green bonds?
Speaker 2 00:01:25 I think it's, uh, very interesting from the perspective that green bonds have been a very popular asset class, and there's been a, uh, two big, uh, demand relative to supply. Uh, but suddenly with the sort of financial crisis that's come here, uh, there's plenty of green bonds to access out there. There's plenty of interesting investing opportunities. And we also have a situation where, uh, there is this thing called additionality with green bonds. Green bonds are actually able to finance things that wouldn't get financed otherwise in this new situation that we are in, uh, compared to, for example, it's just like a month and a half ago. So that's a very big and substantial change to the green bond market.
Speaker 1 00:02:05 Mm-hmm. <affirmative>. Okay. So underlying opportunities, um, are, are I should say, underlying, um, risks versus areas that investors may want to go toward right now as it relates to green bonds? What, what are we looking at for them in terms of risks as well as those areas that they may want to pay more attention to right now?
Speaker 2 00:02:26 So what I generally think is that you, you shouldn't forget that green bonds are bonds and they have the same sort of risk on and off element that as, uh, as any other bonds. However, what I think has been illustrated over the, the past, you know, volatility is the fact that green bonds, uh, have maybe not outperformed on the upside in some sense, but you see some of the brown bonds, uh, that are exposed to fossil risks actually, uh, underperforming quite substantially. Uh, and I think that's, uh, sometimes you have to take that perspective that your green bonds is more of, of an insurance versus some of the negative, uh, tail risks rather than, you know, just making a fantastic investment in themselves. So put them in a relative stance and it, it becomes quite interesting quite soon, actually.
Speaker 1 00:03:11 So let's take a little deeper into that. We're talking about the brown bonds. So let's talk about, um, those investors who possibly were able to short, um, you know, a few weeks ago and where they were then versus where they are now. You and I talked a bit about the rating, for example, for Exxon, you know, where it was a couple of weeks ago, and what is the expectation for them to have those types of ratings moving forward? So let's talk about brown bonds specifically and what the risks were a couple of weeks ago, and then what the risk might be now and what your expectations are long term.
Speaker 2 00:03:47 Just a couple of weeks ago, we would see, you know, high rated, uh, bonds such as, you know, Exxon and other of the oil majors. Uh, being at the sort of the AAA or AA type of, uh, rating category. They would be tightening quite, uh, tightly, uh, quite low spreads essentially. And there's been a very substantial, uh, uh, move out in spreads on these bonds. Um, I think I can even, uh, actually on the relative sense can almost go back to the equity market. If you look at the, the, just the equity of Exxon, for example, it's down right now, it's down 47% this year. Whereas, you know, the Dow Jones index is down 32%. And there's been this correlation between not only the Corona crisis, but also the OPEC and sort of the oil glass, uh, initiated by, by the Saudis mm-hmm. <affirmative>. And this has made it like a perfect storm in terms of tail risks when it comes to some of the oil majors and the oil oil industry in general.
Speaker 2 00:04:42 And that is going to have repercussions for a long time. I think, you know, any risk manager in the next decade or so, looking back at, you know, the big risk that we saw out there, which was, uh, March, 2020, they will also see that, you know, these type of assets actually strongly underperformed, especially in a case when you didn't want things to underperform. Uh, so the repercussions of that is going to be big. Um, then you and I also discussed, you know, the, some of the valuation impacts, and I'm, you know, I'm fairly confident in my view that we are going into an energy transition over the next, uh, couple of decades. Uh, I really hope so for the sake of my kids. Uh, and then you look at the name like Exxon, uh, you know, the triple A emblem, uh, of, of the US and global credit markets essentially, and they have, you know, been sliding on, on, on ratings. I think that, you know, by the end of this year, Exxon will not have a AAA rating anymore, and I don't think they will ever actually recover that, uh, that rating, uh, given the business model they are projecting right now. Uh, so there's a certain valuation standpoint you can do that on terms of bond valuations and bond curves, et cetera.
Speaker 1 00:05:52 So if we're talking about looking at fixed income, and if we're looking at the major brown, brown players when it comes to, when it comes to the companies that, um, are fossil fuel, when we think about fossil fuels, we think of these companies. What can institutional investors, switching gears a bit here from fixed income institutional investors who are looking for high dividend yields. I know we're talking about fixed income. I'm just gonna, you know, flip the script a bit and talk about equities. What can they do moving forward? I mean, do we think that these, um, that these oil companies will be able to produce the same dividend yields that equity investors had known them for for years? Or do you see that as changing as well in the equities market?
Speaker 2 00:06:35 Well, I have a specific investment hypothesis here from my side, and that's, that's taking it from the more, the long short, uh, hedge fund, uh, perspective. Um, if you look at, again, a company like Exxon, I think at the current valuation they're paying, uh, something like a dividend yield, implied dividend yield of over 10%. Uh, and then you, uh, compare that with regards to the sort of the yields that you get or the spreads that you get if you invest on the credit side, which is, you know, pretty, uh, small compared to what you have on the dividend yield side. I mean, one thing, one could argue here is why don't you invest a small sliver in the equity side? You work the case for these companies that you actually don't want, you want them to cease with their activities. You act in a way that they actually keep paying out high dividends rather than invested in CapEx. And if they run out the money, well then you ask them to actually, uh, borrow money in the credit market. So you put on a short, on the credit side and you are slightly long on, on the equity side, and you can start actually playing around with this in a, in a, in a more creative manner, I think, than just, you know, invest or divest, uh, in the traditional E S G investment style.
Speaker 1 00:07:50 Okay, great. Great. So it's short on the credit side and just slightly long on the equity side, that will be your, your solution for that?
Speaker 2 00:07:57 Yeah, the dividend yield pays a lot of your costs of being short, or actually you can lever up the short side a lot given that dividend yields are so high, uh, on the equity side and, and it's essentially, you know, making the company pay for, uh, pay you for being short on on their bonds.
Speaker 1 00:08:15 Mm-hmm. Nice. Great. I, I wanna switch gears back to, to go back to the, to the fixed income markets we're just talking about. Um, but appreciate that that pivot there. Very interesting. When we look at institutions, so the super nationals and the sovereign funds, um, where do you think their role is in terms of stepping in right now to, um, help with the recovery?
Speaker 2 00:08:38 So I think they have a, a very big role to play here. Um, there's been a fair number of commitments, public and non-public, uh, over the past, you know, year, uh, or several years, uh, from various public institutions to invest much more in green bonds. A lot of these institutions have run into a hurdle, uh, or an obstacle in the sense that there hasn't been enough supply in the green bond market. It has looked quite expensive. Now is the time when they can actually step up. And we have an example in Scandinavia, something called the Nordic Investment Bank. They committed 500 million euros to buying green bonds by November last year they had 130 million invested. Uh, I mean, if there is a time when they should put their money to work, it should be now. Um, both I think, and that's myself as you know, trading as a trader, uh, speaking. I think the valuations are, are very interesting for them to do it now. And it's also this time when the market and the issues of this green capital, they actually need the support. Uh, so I think it's extremely important that some of these, uh, institutions step up in that they do it quickly, uh, rather than, you know, wait six months because we don't know, uh, what the situation is going to look like then the opportunity might have been missed already.
Speaker 1 00:09:54 Mm-hmm. <affirmative>. Absolutely. Absolutely. And taking this just a step further and talking about where we are, where the market is in context of the UN STGs, the UN sustainable development goals, what do you think the role may be for, um, the SDGs to play in terms of guiding us toward a recovery? Do you see there, do you see that there is a role, first of all? And if so, what is that?
Speaker 2 00:10:20 I think they definitely do have a, a huge role to play, uh, in this recovery. Um, I don't see that, you know, playing such a big role when it comes to straight investment, uh, activities in terms of, uh, portfolio management, et cetera. It's just too volatile. There's too much happening and there's, it's too hard to sort of nail down some of the SDG effects quantitatively into a portfolio. Uh, it's, it's very important for investors to engage and work with the company. So they actually act in a, in a sort of a social and, uh, SDG compliant way in the recovery process. But it's not, it's not something which is directly investible, but I do think, you know, the climate dimension is where it's actually, uh, already investible where there is an asset class and there is a sort of good divisions between good and bad assets, and you can reallocate your portfolio right now. So on the sort of the climate related, I think it's SDG 13, uh, it's definitely something where you can put a lot of, uh, weight right now.
Speaker 1 00:11:19 Mm-hmm. Absolutely. Yes. And in terms of the roadmap, if you had to give three top areas that institutional investors should consider for their post-crisis roadmap, what would those top three areas be or those top three things be? And this can be in context of the fixed income markets.
Speaker 2 00:11:39 So I mean, my, my first takeaway is returns. This is an opportunity. Uh, I think you should be invested, uh, because it's, it, it, it just looks quite attractive and the green asset class will grow, uh, immensely over the next decade. So you better be ahead of that curve rather than behind it. Uh, the second, uh, part I'd like to say something about is, uh, you know, uh, almost from a quantitative risk manner, um, what we've seen going through the markets will affect how we allocate risk and risk budgeting over, uh, over a long time. So you will see certain type of assets that got hit, uh, badly, uh, to actually be much less attractive coming out of this than they were going into it. Uh, so, so that's, that's a conclusion. You can start drawing that already and sort of reallocate your portfolio. Uh, lastly, I also think, you know, uh, fiduciary risk used to be this sort of, uh, almost, uh, uh, we cannot do anything but, you know, look for risk return on a sort of one month rolling basis. Now we wi witness, uh, you know, the biggest hail risk, uh, since the great financial crisis, uh, we have to start thinking about how do we implement tail risk, uh, hedges in terms of our fiduciary duty as well. It's ha it has to be part of that discussion. And I think, you know, uh, tail risk hedging vis-a-vis, uh, climate risk, for example, is something that, you know, we should be a part of every portfolio and should be only enhanced by this, this, uh, this greater focus on, on fiduciary duty in a broader sense.
Speaker 1 00:13:15 So first of all, green assets grow going over the next decade as your prediction really changing how we allocate risk and looking at the assets that, uh, may be a little less attractive than they were before. And then finally, um, judiciary risks specifically till risk hedging. Great. Um, top three points. All thank you so much for joining us.
Speaker 2 00:13:36 My pleasure. My pleasure.
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