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We speak to Shyam Gharial, sustainable investing researcher at LCP, on a big research project he’s been doing. He has been looking at setting up corporate bond mandates with sustainability criteria. It aims to tilt portfolios away from companies with bonds most exposed to sustainability-related risks. This has had some interesting results and is particularly relevant for DB pension schemes.

With many defined benefit pension schemes reducing their equity allocations, they may well find their biggest climate exposures in their bond portfolios over the next 10 years. How are bond managers looking at climate risks and transition risks and how can portfolios be set up to better align with sustainability criteria?

We discuss 

• Increasingly sustainability is being recognised as something that has been neglected in managing investments and companies, and this has led to systemic risks. Climate change is one of these but not the only one. It also includes biodiversity loss, water risk, natural habitats as well as broader social factors impacting communities and particular segments of populations.

• Aligning equity mandates with sustainability criteria has become a very popular thing to do and is a relatively well-trodden area with many funds and indices launched. Remains less so when it comes to bonds.

• Many investors – but particularly UK defined benefit pension schemes – hold increasingly large portfolios of high-quality corporate bonds. These are expected to be paid back over the next 20 years or more which make them very sensitive to longer-term emerging risks such as these sustainability issues.

• The most obvious ones are climate related, eg stranded fossil fuel assets and/or sharp changes of regulation to meet climate targets that have far-reaching impacts on particular sectors (or companies within a sector that have not addressed the issue strategically).

• These criteria can be incorporated into bond portfolios so that the bonds selected are better aligned with the low-carbon transition, or with broader sustainability fundamentals meaning they are less at risk.

• Managers incorporate these criteria in a number of ways but many use proprietary models to assess future climate-alignment and bring together a range of sustainability factors together into a portfolio management tool.

• This is different to investment in green bonds or social bonds. What we’re talking about here is often what’s called “unlabelled” bonds, ie the general universe of bonds issued by companies. We are talking about sorting this universe in specific ways to align the portfolio with certain risk factors.

• More detail in LCP’s blog here 

One thing to takeaway

You can tilt your bond portfolio to focus on more sustainability aligned companies without compromising yield.

Most underappreciated thing 

That the investment industry doesn’t exist in isolation in a silo. It’s part of the broader world and broader factors should be incorporated outside just returns.

Additional links and recommendations

• Carbon footprinting website links:
  • Carbonindependent.org
  • Wren.co/calculator
  • Climatehero.me
• IEA report covered by the BBC as “ban on gas boilers from 2025 to be Net Zero”
• IFoA Sustainable Development Goals podcast webpage
• IFoA sustainability finance community
• LinkedIn Group 
• Newsletter sign up page
• Boogie Woogie Monster children's book link to online retailer
• Shayam’s music

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Each LCP investment uncut podcast is for information and marketing purposes only and does not constitute any form of investment or financial advice or a financial promotion (under the Financial Services and Markets Act 2000). All views expressed by the podcast hosts and guests are purely their own opinions and do not represent those of LCP, its clients or affiliates. Our podcast listeners should always seek independent financial or legal advice before making any financial or investment decisions. Please refer to the Legal Notices section on the LCP website for further information.​