Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name Stewart Foley, I'll be your host. Welcome back. It's so nice to have you. Today's theme is myth busting within the fixed income universe, and I love this. This is going to be a great podcast and we're joined by Steve Liberatore, who is a senior managing director, head of ESG Impact Investing Global Fixed Income at Nuveen. Steve, welcome. Thanks for taking the time to be on.
Stephen: Thank you so much for having me.
Stewart: It's a pleasure, and we are joined also by my good friend Joe Pursley, who is the head of Insurance the Americas at Nuveen. Joe, a fellow car enthusiast, racing enthusiast, welcome back. It's great to have you.
Joseph: Thanks Stewart. Thanks for having us.
Stewart: We are happy to have you. First of all, I'm a fixed income geek, so this is exciting, but we're here to bust some myths about fixed income. But before we go too much farther, I want to start with Steve, because he's new to this process. Steve, where did you grow up? What was your first job? Not the fancy one, by the way, and what makes insurance asset management so cool?
Stephen: I'm a proud upstate New Yorker. I grew up in a small town in the Finger Lakes in Geneva, New York. It's on top of Seneca Lake, and I am a long-suffering Bills and Sabers fan as a result. My first job, I'm going to have to say certainly wasn't a cool job, was as a paperboy for a weekly paper that was delivered in my hometown. I think what's really interesting about insurance asset management, which is where I actually started my investment career, is I think there's a natural ability to find investments that hedge the business risk of an insurance provider regardless of whether they're life or property and casualty.
Stewart: I love that. That's great. Joe, obviously, close to Watkins Glen where one of my favorite tracks ever. Steve, let's start with this. A lot of investors have a perception that impact investing can only be pursued through equity strategies. How would you respond to that?
Stephen: Yeah, that is, and I'm glad you really, Stewart, you called this kind of the myth busting episode, because that's one of those ones that really sticks out there to me, is kind of based on historical concepts. Usually and historically when you thought of impact investing, most people would immediately revolve to either private equity or venture capital is the only way for you to deliver an impact solution. But I think that the market has come around and had more consensus recognizing that impact can really be driven in any asset class.
It's about how you control the utilization of proceeds and your ability to measure the result. That's why fixed income, especially in the public fixed income space, has been so exciting, because the nature of the way the market is constructed gives you access to how the proceeds are utilized. Most issuers come to the debt markets far more than they ever go to the equity market. The ability for you to then structure a transaction where there are clearly defined use of proceeds and the ability to put within that documentation, the need for relevant and insightful impact data puts you in a different position as an investor. I think the understanding of that, once communicated to an investor, really heightens their interest in the idea itself.
Stewart: Yeah, it's interesting to me, because I almost think about investing, impact investing in fixed income, as another facet of fundamental analysis. It really is. It is an aspect of fixed income that when I was doing it wasn't really on the radar. I think one of the things I fight with all the time is, I've been at this a minute and my perceptions and the way that I remember an asset class has changed. Right, and so one of the nice things about these podcasts is that allows me to get a chance to get current. With that in mind, can you talk a little bit about how the impact bond market has evolved over the past decade or so, and can you give us a couple of examples of impact investments that you've made?
Stephen: I think this is another question, Stewart, that really falls into this myth busting concept, that one of the things that has really gone on around the concept of using ESG as far as the portfolio construction process and now impact investing, is that discussion has almost ignored or really put to the side the reason why you would look for or utilize these types of ideas in constructing a portfolio. Impact investing is one, to me, where it really highlights the opportunity for you to identify issuers or particular investments that, because of the approach they're taking from an impact perspective, ultimately lowers the cost of funding or the cost of financing or the cost of operations such that, that issuer benefits in the long run by being able to generate more stable free cashflow, therefore making it a better investment. We know in fixed income, how you generate excess return isn't picking winners, it's avoiding losers.
By identifying issuers that through their own investment process are stabilizing or increasing the stability of their own free cashflow generation, you are identifying potential outperformance over time. That's really the key of what we're doing, and I think about it, the simplest example I could give would be, think about a utility that's investing or issuing a green bond to fund a solar power project. We'll use the simple one. The reason that renewables like solar and wind have overtaken fossil fuels as far as investment has not been because of the environmental benefit, which is great, it's because they're cheaper. In the long run what's occurring is, as a utility transitions away from fossil fuel utilization to more renewables, their cost base is becoming cheaper, which again is another myth, right? We have been told historically that to use renewables is more expensive. Well, that's false.
We're in a place now where the data shows you that on a utility scale basis, the cheapest form of marginal power is likely a renewable. In the US, if you live in the southwest, solar is your cheapest form of marginal power, in the Midwest, it's wind. What you're seeing are utilities that are transitioning, not just because of the environmental benefit, but because it allows them to have a lower cost basis going forward, which allows them to either reduce or stabilize the prices they're charging to their customers, which by the way, makes the customer more likely to be able to make their own payment, which increases the likelihood that that utility can make the payment back to you as a debt hold. That's what we're looking for, right? We're trying to identify opportunities where the environment impacts society, which impacts the economy, and all of that is a virtuous cycle that we want to explore and try to exploit in the portfolio construction process.
Stewart: Yeah, it's really interesting. We're actually going to be doing a podcast with a woman who wrote an article about the insurance industry and climate risk in the Atlantic. She's going to be on next week. It feels like the insurance industry is shifting away from talking about ESG as a risk factor, and increasing the focus on ESG as an impact opportunity, i.e. a positive story, which you did a beautiful job of laying out exactly how it's not, oh well it's renewable and it's social, but it's a lot more expensive, but we should do it anyway. It's like, no, no, no, no, no, no. I think the Inflation Reduction Act has had, there's been some fiscal angle on this too, right, a bit of a tailwind. How is impact fixed income playing a role in that narrative?
Stephen: I think that what we're seeing is that investors are now able, whether your insurance or not insurance, right, as an investor, you're seeing the opportunity to find market level returns and market rates of return that also have this desired environmental and/or social impact associated with them. What that does is, provides more stability to their investment portfolio. It allows them to identify, again, issuers that are focused on an improvement in their own operations, which again, increases the likelihood of repayment, which increases stability of your balance sheet, which increases the opportunity for you to have more stable charges of premiums going forward and less loss absorption risk going forward.
I think that that's where that natural hedge that I mentioned earlier, I think really works well within the insurance industry is when you start looking at this as an opportunity, versus looking at it purely as a risk mitigate, which also has certain value, there's no doubt about that, but the ability to find it from an opportunistic perspective that drives a certain outcome that has financial benefit and also happens to have a financial hedge in place for you is really a critical factor when trying to evaluate whether or not you should be looking at employing an impact investment strategy, especially one in fixed income and in public fixed income. This is a natural allocation for the insurance industry. When you start thinking about this, we don't have to change our asset allocation profile, and we can look at our, simply looking at our current portfolio process and looking for ways to enhance it in a way that we think over time is going to be beneficial.
Joseph: Steve's touched on some really interesting points there, and I think this has been just a tremendous evolution for the insurance industry over, call it the last 7 to 10 years. I mean, what started as if you go back far enough, really the asset management industry wanted to start to talk to insurance companies, CIOs and insurance company investors about ES&G as a risk factor at the CUSIP level. That was really interesting, but the problem was CIOs have sometimes 9,000 line items across multiple different asset classes and there was no way to aggregate or communicate what you were doing through a risk lens. Well, at TIAA Nuveen, we believe that climate change is an investment risk, and therefore ESG risk factors are things that you want to consider when you're making investment decisions.
But, what's really emerged is moving to that positive side and saying what we can aggregate is we can aggregate some of the carbon reduction that's happened at the portfolio level. We can start to aggregate the years of education that we're providing for underprivileged people or the schools that we're building, hospitals that are being constructed, and that's real data that people care about in the public domain now. As the last 5 or 10 years have gone by, and I'm sure there's really good reasons for it that we could talk about outside of this podcast, but it's just been so encouraging to see the insurance industries leading the way in communicating these things in the public domain. I mean, there are a significant number of insurance companies now who perform sustainability reports, who communicate these factors, and I suspect the rest of the institutional industry will follow over time. But, it's been a really powerful evolution and Steve and I think, and it's still early days on the type of key performance indicators we can actually quantify that show the positive benefit to society and the environment as a result of insurance company investments.
Stewart: Yeah, that's fantastic. That's a great point, Joe, thank you. Just about everybody knows what a green bond is these days, and I think one of the things I'd love to know is are people playing games with that, right? But there's also something called blue bonds and orange bonds, which up until this very moment I was not aware of. Can you talk about those, and are there any other colors that we should be aware of?
Stephen: One of the things to start off with a little bit of background. The main guidelines and framework that's in place in the public fixed income market around whether or not you define something as a green bond is from the International Capital Markets Association Green Bond Principles or GBP. Full disclosure, I was on the original executive committee, so I helped to write them and I've been on the advisory council a couple of times, but I'm no longer serving. That's really a framework that was laid out for issuers and investors to follow to determine whether or not a security fit the definition of green. With all of that as a caveat, my favorite phrase in this space is, just because it says it's a green bond doesn't mean it is, and just because it doesn't say it's a green bond doesn't mean that it isn't.
What's really critical and important in this space is, as an investor, you have to do your due diligence on a security level basis to determine whether or not that security fits your definition of green. That's really something that's lost a lot of times in these discussions - that the green is a subjective concept. What you consider green, Stewart, may be different than what I consider green, right? Most of our investors don't consider nuclear power to be green, but if we were having a discussion in France, most people in France have the belief that nuclear power is green in its current format. One of the things to keep in mind is that, the analysis of the individual security is critical to determine whether or not there's alignment with your views. For us in our approach, we are a use of proceeds investor. For us, an impact investment, which would include a green bond, has to have a direct and measurable environmental and or social outcome associated with it. A green bond, obviously, is funding projects that have a terrestrial base that are environmentally beneficial.
A blue bond is similar. A blue bond are environmental projects that are marine-based instead of terrestrial-based. So, 80% of the globe is water, so the concept of a blue bond, which is fairly nascent, is growing more rapidly because we're recognizing on a daily basis to how much the health of the oceans matter to air quality, water quality, weather patterns and the like. Now we're starting to look at opportunities to invest in projects that are focused on marine outcomes.
An orange bond is the next step in the social bond market, where a social bond similar to a green bond, social bond has a direct and measurable societal outcome. Think of things like affordable housing or community and economic development projects. An orange bond is taking that one more step further by focusing purely on gender lens investment opportunities, so directing capital to underserved women, or women that live in markets where they don't have as much access to financial products. That's really being driven off of something called the orange bond principles, with orange being the choice of color because that is the UN SDG color, or sustainable development goal color, for gender equality. That is the opportunity to look for specific outcomes where you're lending money or providing capital to women around the world.
One of the things, again, that's important to know is, that the identification of opportunities that would fall into this impact concept is going to be different for different investors. Because again, it's going to align with their particular views. We utilize the labeled market, so labeled being green bonds, social bond, sustainability bond where there's green and social components, and I think that's where the market is really going. Where again, going back to the concept of the environment impacting society which impacts the economy, and within the sustainable bond market, we have a really good example there of something interesting that we think is reflective of the way we look at the market.
We invested in a mobile home park in Sonoma, in California, and about 87% of the 360 units were for individuals that would be considered low or very low income. Sonoma is an extremely expensive place to live, and so that particular park is of really important stock of affordable housing units, and it's equivalent to roughly the same number of units that the county has been able to build over the last, call it 20, 25 years. But, the management team of this park is very thoughtful, very forward-looking.
The reason it's so expensive to live in Sonoma is because of the sun and the environment. What they did was they also, in this transaction, invested in a solar power array on grounds. That solar power array on grounds has helped to reduce the cost for the residents by over 90% for power. Thinking about this, that is the perfect example of a societal benefit being further supported by an economic benefit, which then ties back to, well, if the residents have a power cost that goes down by 90%, they're far more likely to be able to make their payments on a monthly basis, which means that borrower at the issuer level is far more likely to be able to pay you back. That's again, a great example of what we're trying to look at is, how do these factors generate an economic benefit. What we have seen is that the labeled green social and sustainable bond market is a good proxy for what we consider to be the eligible universe.
In 2021, we had over a trillion dollars of issuance. In 2022, we only had about $850 billion. Now, keep in mind the overall fixed income market was down about 25% in issuance last year. The labeled market was only down about 7%, so proportionally you saw an increase. This year we're on track to have over a trillion dollars of issuance. That's going to get us to a place where the outstanding market is, call it four or four and a half trillion, but also representing roughly 15% of total issuance within the public fixed income market is coming with a label. The opportunity set is continuing to grow, and for us, that's fantastic because as an active total return manager, the greater the opportunity set, the greater the chances for us to be able to outperform over time. Also, because the market is becoming more granular in the impacts that it's achieving, that allows us to more closely align portfolios for our investors that are in alignment with what they're trying to get accomplished.
Stewart: Yeah, that makes total sense. It's amazing that market's that big. I mean, that's incredible. What everybody, and you touched on this earlier, right, is you go, well, insurance companies can literally directly, let's just say it like this, it is certainly in my mind logical that insurance companies have a unique opportunity to use their assets to reduce their liabilities, right? I mean, let's not kid ourselves about what we're talking about here. When extreme weather events happen, it's the people who listen to this podcast whose phones ring. Right, And so it makes sense to me that insurance companies would be keenly interested, particularly given that investment grade fixed income is a substantial portion of every insurance company I've ever been associated with or seen to this point. But what always comes back is, you know what, my job as a fiduciary, and if something chugging black smoke in the air is two basis points wide as something that's green, give me the two basis points and I'll see you later.
Stewart: What about the returns of impact fixed income?
Stephen: I think this is a fantastic question that continues this theme of myth busting. The belief that you sacrifice performance to be a responsible investor is exactly that. It is a myth and it is important, I think, to note that it may be based on historical approaches to responsible investing, where maybe you were excluding entire sectors of the market and you were only looking at it from a risk litigant, not necessarily from an opportunity perspective.
The issue is that the market has evolved to a place where if you're doing this correctly and applying ESG factors and impact investing in a portfolio construction process, where you're trying to identify opportunity financially, you are not in a position where you're going to sacrifice performance. If anything, it should be additive to performance.
Stewart: It makes sense to me that it would be additive for the reasons that you're talking about, right? It makes economic sense and it's interesting to see that the performance backs that up. One of the things that I've heard historically is, from large institutional investors like insurance companies is, that they can't scale. But you've addressed some of the issues around the market size and it sounds like that's changing. Can you talk a little bit about what's going on with regard to market size and the ability to scale?
Stephen: That's the other thing that's great about the public fixed income market. The greatest strength, the greatest advantage of the public fixed market is the ability to scale, and do it quickly, and do it on a continual basis. What we have seen, and for all of us on here that are capital markets people, one thing we know for sure where there's demand, the market will create supply. The ability for people to become more sustainable, as we've seen growth in ESG and impact strategies from an AUM perspective, outpace non-ESG and impact strategies continually over the years.
Because of that, we've seen an ever-increasing opportunity set to invest. As that demand continues to increase, we're going to see issuers respond, because there's a desire to obtain capital from people who are looking at investing through ESG factors or through impact. One of the biggest strengths there is that the capital deployed by dedicated ESG and or impact investors does tend to be longer term focused. They understand that the things they're investing in today are going to take a while to become evident, so there is more patient capital. It's also a marginal area of capital for a lot of issuers, which gives an advantage for creating securities that have more sustainability associated with them, because you're going to be able to attract a different pool of investors.
Stewart: Yeah, I love that. I mean, I have learned so much from you today. It's interesting how the fixed income market has evolved to a place that is, I mean, from the last time I ran money, unrecognizable, right? It's a very different environment today than it has been, and I really appreciate you being on and giving us a really solid education today. I've got a fun couple of questions for you on the way out the door. You and Joe can battle over who's going to answer what, but usually we have optionality. You can take your pick, but with people that have been in this business as long as you two have, I think you can handle these. All right, you ready? Number one, what's the best piece of advice you've gotten or given, and number two is who would you most like to have lunch with, alive or dead?
Stephen: I will defer to you. You go ahead and pick. I'll take the other one.
Joseph: Yeah, I'll take it to a personal note. I think it was maybe a PSA in the eighties or early nineties that I remember and has always stuck with me as fantastic advice being a parent of three kids is, you don't have to be perfect to be a perfect parent. I had it stuck with me as a parent, but also through my career of being a manager and just engaging with people in general. You can try hard and that's good. Perfect is difficult to achieve and that's okay.
Stewart: That's fantastic. Steve, what about, who'd you most like to go to lunch with, alive or dead?
Stephen: I'm going to probably go with someone that's a little bit off, probably not what most people would think of, but I'm going to say Joe DiMaggio. I'm a big baseball fan and I'm the son of two immigrants. Well, I should say my father was born in the US, but my grandfather immigrated from Italy and my mom is from Belgium. My dad's army unit liberated my mother's hometown during World War II, and that's how they met. I remember, I unfortunately never got a chance to meet my grandfather who immigrated from Italy, but I always remember the stories that were told about him that, about coming to this country and the opportunity that it presented.
But, I remember him specifically saying that he was convinced, even though my father and his four brothers all volunteered for World War II, and that Italians made up the greatest portion of volunteers in World War II, because they were trying to prove they were American, that if it wasn't for Joe DiMaggio, that Italians may have been put in internment camps as well. I think it's interesting to me to think about that time in our history and how different things could have turned out if not for the influence of one individual, who was playing a sport of all things. But, it would be interesting to me to hear from him how he experienced that, and did he feel any type of pressure or threats to try to represent an entire community at that point in time, when obviously tensions were running extremely high.
Stewart: Wow, that's cool. That's really interesting. Good stuff. I really appreciate you both being on today. We've done our fair share of myth busting and very happy to have you both on. Thanks so much for taking the time today, guys.
Joseph: Thanks for having us.
Stephen: Thanks for having us, Stewart.
Stewart: My pleasure. We've been joined by Steve Liberatore, senior managing director, head of ESG Impact Global Fixed Income at Nuveen, and Joe Pursley, head of Insurance of the Americas at Nuveen. Thanks for listening. If you like us, please rate us, review us on Apple Podcast, Spotify, or wherever you get your favorite shows. My name's Stewart Foley, and this is the InsuranceAUM podcast.
Investing involves risk; loss of principal is possible. Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well. Nuveen, LLC provides investment solutions through its investment specialists.
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