Stewart: Impact investing is certainly a hot topic with insurers these days, but what does impact investing mean? We're joined by Matt Lawton, portfolio manager in the Fixed Income Division at T. Rowe Price. He manages Global Impact Credit Strategy and co-manages the US Investment Grade Corporate Bond Strategy. Matt, you're a vice president and member of the Investment Advisory Committee for the Corporate Income, New Income, and Ultra Short-Term Bond Funds, and you're also a vice president of the Short Term Bond Fund. Welcome and thanks for being on.
Matt: Great Stewart, thanks for having me.
Stewart: It's exciting out here about impact investing in ESG, but before we get into that, I'll start this how we start them all. What's your hometown, your first job of any kind? Not a fancy one, the first one, and a fun fact?
Matt: Okay, so hometown, Frederick, Maryland. It's about an hour west of where I sit today in the T. Rowe Price, Baltimore office. My first job was at the Sunglass Hut where I was selling sunglasses and watches in a kiosk at the Francis Scott Key Mall in Frederick.
Stewart: There you go.
Matt: And then shortly after that, I found myself at an internship at a bank, and then it was straight-line finance from there.
Stewart: Nice.
Matt: And fun fact. We'll say fun/embarrassing fact. I think I saw the movie Jaws when I was like seven years old and did not go into the ocean for probably a solid almost 10 years after that.
Stewart: That's awesome.
Matt: The fear of what was underneath, and we go to the beach maybe a couple times a year, and even still today I'll only go up to my waist when going into the ocean. I could thank my mom and dad for exposing that to me at probably too young of an age.
Stewart: That's fantastic. I used to have a client in Frederick, Maryland. I've been there a few times. It's a beautiful, beautiful place. So, just starting from the top, what's the difference between impact investing and the letters we hear so much about: ESG?
Matt: Great question. So, as I have found sitting in this role, Impact Portfolio Manager, all things ESG terms get thrown around rather loosely and liberally and it can mean different things to different people. So, a good level setting starting point.
Impact investments are investments that are made with the intention to generate positive environmental and social impact alongside a financial return. And that those two objectives, i.e., impact and financial return sit in equal priority to each other. Where that differs relative to ESG? Think of ESG as something that's focused on the inputs of a particular business. So, a company has good governance mechanisms, they have good diversity statistics, they have a low carbon footprint, while impact investing is more focused on the outputs. So, what is the impact of a particular business model on the environment and on the society at large? So, if you think about the ecosystem of ESG, the broad sort of ecosystem, impact investing sits on the dark green, or the most environmentally and socially focused side of the spectrum in its approach. So, that's kind of how I would differentiate impact investing relative to ESG.
Stewart: And is it fair to say that historically impact investing has been associated with private markets? Is that true and has it changed over the last little bit here?
Matt: Historically, that's absolutely been the case. That is impact investing does have its roots in private market investing, but that is changing drastically over the past few years and something we expect to continue to change going forward. The reality is that public fixed income, and particularly corporate credit, presents a fertile ground for impact investment opportunities. And if you think about the role that public fixed income and, again, particularly corporate credit can play in the impact investing ecosystem, really what credit markets can do is facilitate the flow of capital from end investors to the very projects and institutions that are best placed to drive positive environmental and social impact at scale. Really driving sort of substantive progress in the fight against climate change and other environmental and social pressures, also demand significant capital investment which simply cannot be delivered through private markets alone. Think about the UN SDGs for example. So, research would say that $5 to $7 trillion of investment is needed per year to achieve a set of the UN Sustainable Development Goals or SDGs. So, quite frankly, public fixed income is not only helpful in facilitating, in financing that investment, it's actually necessary.
And then if you think about it from an issuer perspective, public markets, public corporate credit, provides a much deeper pool of capital to help fund those businesses, to help fund those projects that are delivering positive environmental and social impact in a depth that quite frankly, again, private markets really cannot deliver.
And then just a last point on this, the universe of impact investment opportunities in public fixed income is growing every day. And the reason it's growing every day is you have new companies and new sectors that are coming to the ESG-labeled bond market, like the green bond market, for the very first time. So, we have new companies and new sectors that are joining the impact investible universe every day. And that presents, obviously, great investment opportunities for public credit managers like myself.
Stewart: It's interesting, I would argue that nobody has more skin in the climate game than insurance companies do, right? Wind blows, hail falls out of the sky, all of that, all those extreme weather events, insurance companies are writing checks. They are sitting in a very powerful seat to use their asset side of their balance sheet to help positively impact the liability side of their balance sheet, right. Now, you mentioned a couple of terms. I'm a fixed income geek, but I'm not an impact investment expert by any means. So, let's talk about green bonds. First, I'd like to define what they are. And also, are they the only avenue in here? And while we're at it, someone used this term the other day, what is greenwashing?
Matt: So, great questions there Stewart. So, just to define that term, green bonds; a green bond is a bond where the proceeds from that particular security are allocated to discrete environmental projects, and it's the expectation that that project investment is going to yield positive and measurable environmental impact. I would say too, that is just one avenue of the broader ESG-labeled bond market ecosystem. You have green bonds, social bonds, which is a similar construct, and the proceeds are earmarked for social projects, and then sustainability bonds which allocate to a combination of environmental and social projects. So, just to level set that.
Greenwashing, to define the term greenwashing. I think of that as a tension or conflict between the narrative of a particular company, or a particular issue, or project and the underlying substance or environmental benefit that company or that project is providing. When the narrative over weighs the substance is when you have the greenwashing dynamic at play.
Stewart: So, thank you for that. Are green bonds my only avenue? So, we talked a little bit about this at the top, but core bonds are the predominant asset class, less than they used to be, but still a huge portion of virtually every insurance company's portfolio. And so, when I look at my IG fixed income portfolio, are green bonds my only avenue in the public fixed income markets?
Matt: So, absolutely not. It's fact, we very, I would say strongly believe that impact investing can and should go beyond green bonds, right? I think if you look at a lot of the other public credit, or public fixed income approaches to impact investing, they do tend to focus on green bonds. I believe that is a flawed approach for a number of reasons. Just to name a few, the market suffers from very high sector concentration. So, 70% of green bonds come from two sectors, financials and utilities. You have this greenium dynamic in public corporate credit, where green bonds tend to stubbornly trade rich relative to their conventional counterparts, which is a risk if you're only beholden to green bonds. And then we have the greenwashing dynamic that we previously discussed. So, I think, quite frankly, it's a flawed approach if you're focusing exclusively on green bonds.
So, we look to a broader corporate credit investible universe for impact opportunities. And let me give you just a couple examples of some high-impact, non-label bonds that we look at today that we think offer pretty compelling impact, as well as financial potential. So, you could think of a company like a renewable energy developer where they're investing into a portfolio of wind, solar, battery storage generation. You could have an emerging market bank that focuses on consumer and SME lending. You could have a not-for-profit pediatric hospital that is providing positive social good that is aligned with the SVG of good health and wellbeing. So, those sorts of companies may not issue green bonds, or social bonds, or sustainability bonds, but their inherent business activity, their inherent business model, is providing positive impact. So, we look at those types of opportunities as really compelling impact investments alongside green bonds.
Stewart: And this is going to show my naivete, but it's been shown so often I'm pretty immune to it. When bonds are classified as green bonds, how uniform is that construct? In other words, how close are we to an agreed-upon standard of what's green and what isn't? And you mentioned labeled and not labeled. Can you talk a little bit about it, because to me it seems like there's a lot of different scorekeeping mechanisms that might not all align perfectly. So, can you talk a little bit about how you deal with that?
Matt: Sure. It is an unfortunate condition in the marketplace that there is a wide, we'll say wide variety of quality of green bonds that are in the market today. And just to back up for a little bit of context, the International Capital Markets Association, or ICMA, has provided guidance to the marketplace for what they believe constitutes a green bond, or the types of projects that qualify a bond as green. However, that guidance could be very loosely interpreted and the application of that guidance varies quite a bit. So, if you think about one example, or one sector that is a prolific issue of green bonds, utilities. You can have a utility issue of green bond that goes towards funding smart metering, which is basic energy efficiency, R&D type level expenditures. Or you could have a utility issue a green bond that funds offshore wind, which is a much higher impact investment, provides a measurable degree of environmental impact in the form of carbon avoided, and provides a level of additionality that is in far excess of a smart metering investment.
So, how do you navigate this wide variety of qualities and structures? So, we think it's important to apply sort of a systematic framework for assessing the quality of green bonds. One where we look at the issuer that's issuing the green bond because I think it's important that you can't disentangle the issuer from the issue and the project itself. We look at the framework and whether it's aligned with international standards, whether or not there's a tight governance structure around project selection. We look at the use of proceeds. So, thinking about those project examples, we look at the ambition level of the projects that are being financed, and whether or not they're providing a material degree of positive impact. And then lastly, one year after the bond is issued, the company will file what's called a post-issuance allocation report. And then we'll interrogate that report to see where the proceeds went and what granularity are they disclosing the allocation of those proceeds, whether or not there's impact key performance indicators, or KPIs, that they're reporting alongside that allocation, and whether or not that proceeds allocation was audited.
So, an application of that framework really kind of helps us assess the quality of green bonds and ensuring that when we're allocating capital, we're doing so to the most impactful or the most positive green bonds that are available to us.
Stewart: And I mean this really gets into fundamental investment analysis, but it is fundamental analysis on a different level. This is T. Rowe Price proprietary fundamental security analysis. There is no shortcut. This is roll up your sleeves, and review the documents, and dig in there, right? I mean, there's no such thing as just looking at some score on a database download and saying, "Okay, we're all done." This is fundamental security analysis at its core. Have I got that right?
Matt: 100%. These are not facts you can download, or analysis you can download in Bloomberg, and have it update an Excel, and update a score in a model. This is something that really does require, it's a labor-intensive approach, it's a manual approach.
And one, I could say, additional area of diligence that is often involved that we didn't talk about, is engagement with our companies, as well, that we're investing in. So, plenty of examples where we've assessed the framework, maybe we have some lingering questions, because the data's not all there, the disclosure's not all there, or we want to maybe tease out what some of the impact KPIs are going to be with an associated project. We'll engage with the company. We did that last week, actually, with a number of our investment companies, where we had deeper discussions on the project that they were financing, and what we thought, and what they thought the associated impact was going to be from that. So, again, not something you can, unfortunately, just download in Bloomberg, and put onto your desktop, and then make a buy-sell decision off the back of it.
Stewart: And in a similar way that fundamental analysis would be done to figure out relative value of, just forget about green for a second, just looking at spreads, and credit quality, and just the core fundamental concepts, right. Now we're going to layer on impact investing and the quality of the impact scoring, if you will, and then you've got to layer on the relative value. Because you said earlier, at least I think you did, that sometimes green bonds trade rich to their non-green labeled counterparts. So, there's a relative value equation here that you're sifting through that's very labor intensive. That is an important part of this, because at the end of the day, investors, your performance matters, right? I mean, regular, good old performance matters in addition to this. So, I mean, that's an important part of your relative value analysis I would think, right?
Matt: Absolutely right, because if you recall, at the top of the interview we talked about what are the two mandates for impact investing, it's impact and financial return. And you can't sacrifice the financial return mandate simply because a bond provides positive impact. You have to have the financial case underwritten, alongside the impact case. And this is an issue, as you rightly noted, that is a lot more prolific in the green bond market for the greenium issues we previously discussed. So, it's almost like step two. So, step one, interrogate the impact fundamentals of the particular bond in question. Step two, assess the fundamental merits of the security in question. And both of those have to be in sync. And it's my belief that we should not be paying through fundamental fair value for a bond simply because it's green. And fortunately, the market is broad enough, and the market is deep enough, where we don't have to do that.
So, if we're looking at a particular company, particular green bond, the impact case is strong, but it's trading 20 basis points inside it's conventional bond counterpart, we're not going to buy that, right? Because we would then be seating or sacrificing our financial mandate. We'll wait for valuation to converge to a fair value level, and at that point we would consider investing in that security, assuming the impact case still holds. So, it is an unfortunate condition we have to navigate, but again, fortunately because the market is broad and deep enough, not one we're beholden to.
Stewart: Okay, so the way that I look at it is how do you qualify, or how do you quantify the impact nature of a bond that isn't scored as a green bond per se?
Matt: That's a great question and perhaps one that doesn't have an obvious answer. So, to think back to the examples we talked about earlier, for companies through their everyday activities provide positive impact. So, how do you assess those types of companies and actually qualify them as impact? So, there's really sort of three key steps that we apply when we're looking at a non-labeled bond and ascertaining whether or not it has impact potential.
So, one is alignment. And when I say alignment, I mean impact alignment of either revenues, or proceeds of a bond, with the UN Sustainable Development Goals. Or in the case of T. Rowe Price, we also have a proprietary impact pillar framework that looks at climate, and social, and sustainable innovation and productivity. And revenue alignment with those three impact pillars is step one.
Step two is carrying out a more formal impact due diligence framework. And the framework that we apply in our strategy is the Five Dimensions of Impact Framework, where our analysts will ask and answer questions of a particular company and investment saying "What is the outcome that we're hoping to achieve? Who is being affected? How much impact is occurring? What is the contribution from the investor? And what is the contribution from the enterprise?" And then lastly, "What are the risks, the impact risks of a particular investment?"
And then the third step is measurement. And that is every investment that we make has some sort of impact-oriented KPI, or key performance indicator, that we attach to that investment. And then we record it, we measure it, and then we report on it over time. So, bringing those three key steps together, alignment, impact, due diligence, and measurement. If you do those and you do those well, I think you can absolutely qualify a non-labeled bond as an impact bond.
Stewart: It's really interesting to me, because what you're really laying out is an entirely additional layer of roll-up-your-sleeves fundamental analysis on each investment, beyond your standard credit work. This is another level. And you're talking about a proprietary framework that is pure fundamental analysis, if I'm understanding how you're explaining it. Am I right there?
Matt: Yeah, it's exactly right. So, to give you an example, we look at a particular renewable energy company in the strategy and we can essentially measure the amount of carbon that was avoided as a result of that company's assets and activities, right. And the amount of carbon that's avoided is not something that you can just look up on the website, or download from Bloomberg every month. It's something that you have to actually, as you said, roll up your sleeves. Look at what is the CapEx investing? What has been the amount of megawatts of installed capacity across the wind, solar, and battery portfolio? How much clean energy was then generated as a result of this assets? And then, as a result of that, what has been the impact of those activities, as in, how much carbon was avoided as a result of that? And to your point, those are numbers, or those are analysis, that is only uncovered through pretty labor-intensive and manual approach to impact research.
Stewart: But it's a completely additional facet of fundamental analysis and relative value. The greenness, this is my term, the greenness of a particular investment, really unearthing that, and how that's priced, and making that relative value assessment, is absolutely value add from an asset manager's perspective. I mean, it certainly seems that way to me. Is that how you view it as well, Matt?
Matt: Right. So, if you think about every investment that we make has to be underwritten on an impact case, as well as a fundamental and financial case. And so, when we look at a particular company, we may see a bond or company that presents compelling future impact potential that perhaps isn't priced into the market today. But it's our belief that as that impact story is better understood by the market, there is a financial return case that can be made, whereas that story is better understood, then the yields tighten, the price of the bond goes up, and then our clients will accrue that financial benefit from that investment as well. But, going back to the point, that it does, importantly, that every bond, a company has to be interrogated from both the fundamental, as well as the impact side.
Stewart: There are insurers out there, and I mentioned at the top of the show, who are very concerned about climate. And one of our executive council members was in the Wall Street Journal recently offering premium discounts to their clients who have climate initiatives. Our audience is insurance investors, overwhelmingly. How are you seeing impact investing fitting specifically into an insurance portfolio? Are there nuances that your insurance clients are concerned about that maybe others aren't? What are the nuances there?
Matt: Sure. So, just to level set, we talk about impact investing. We're not talking about a new asset class here, right. So, if any investment allocator, be it insurance or not, let's say they have a core allocation to investment grade credit, they could look at an impact investing investment grade credit strategy as either a complement to or a replacement of a core IG credit allocation. Because, and the reason why I say that, is because achieving impact through bonds does not require an overhaul in the traditional portfolio construction process. It is basic bond investing, it's basic portfolio construction, through an impact lens. So, to that point, and to your question, I would emphasize that a fixed income impact portfolio could be flexibly managed to any client objective. And that's something that we are often having discussions with clients about, where a client desires to have impact through an environmental and social lens, but maybe only wants to do it through a certain currency. Or they desire impact but they only want investment-grade-rated bonds. Or they have a duration constraint.
And so, we work with clients on these exact issues. We have a variety, I would say, of model portfolios that span the risk spectrum when it comes to spread tracking, error duration, et cetera, but all deliver impact. And so, I think that's an important point to emphasize, is that one can achieve, an insurance investor could achieve impact with a flexible approach that is tailored to their specific objectives.
Stewart: It's an interesting point, Matt, because your insurance company clients, particularly P&C, where they've got climate-exposed liabilities all over their balance sheet, it seems to make sense that if we've already got a large allocation to IG fixed income, why not put an impact lens on that? And it seems like that just makes sense at a base level to me. You mentioned duration constraint. When you see issuance of green bonds, or impact bonds, through an impact investing lens, I'm not asking that question very well. But are there limits or are there areas on the yield curve that you're seeing more issuance than less issuance when you're looking out at the opportunity set?
Matt: I would say specifically within green bonds, the duration profile of that particular label does tend to skew a little bit longer than your generic corporate credit index or benchmark. And I think part of the reason why is the underlying profile of the issuers that are commonly coming to market with green bonds, think of the utility for example. Utilities like to issue longer-duration debt because they can. The market is willing to fund those types of business models in a longer duration, so that does tend to come with a longer duration.
But I think for any duration-sensitive investor, and I think this is a particularly acute issue now given the recent rate moves that we've been experiencing for the past several months, is quite frankly some investors, they want the impact but they don't want the duration, right? And so, how do you navigate that issue? And one way is through deliberate security selection within a green bond market. You can skew your security selection down the yield curve and achieve it that way.
But also, just sort of going back to the earlier point, I think that raises the importance of going beyond labeled bonds in an impact investment approach, right? Because if you're not constrained by a label, you can find good impact investment opportunities across the yield curve, across sectors, across labels, you can more specifically achieve a client's investment goals as it pertains to duration without, again, sort of being beholden to that green label.
Stewart: That's fantastic. I love these podcasts. I get to learn so much. It's such a great advantage for me, because I get to talk to experts like you and get educated on impact investing in green bonds and so forth. And just to kind of wrap up here, and I really appreciate you being on, one of the things I've got a soft spot in my heart for is college students and people coming out of school. And I would just take you back to earlier in your career, as you were coming out of school, and looking out into the market, because there's so much of the investment market that has changed as it relates to impact investing in green bonds. And there're considerations that when I started weren't issues, not on anybody's radar screen. For a young person coming out of school today, or for yourself, what advice, what would you suggest that someone consider when they're looking out at building a career in the financial services and particularly the asset management world today?
Matt: That's a great question. I think a few things come to mind in answering that question. So, one is a strong work ethic and good attitude can matter a lot in the early years of your career. And that's one where I have found that doing those basic things like coming to work with a good attitude and working hard can really take you far early in your career. And obviously what matters for development and advancement thereafter can and will change quite a bit.
The second thing is to be kind to others. I think kindness is an attribute that is, it's intentional, it's deliberate, and quite frankly, it's a lot easier to go through life when you have that perspective and often is reciprocated in such a way that the environment that you're working in is a more enjoyable one.
And the last thing I would say is to say yes as much as possible. One thing that I have found in my career is no matter how perhaps uncomfortable or out of reach an opportunity that has been thrown at me may seem, I have found that saying yes to those opportunities has often led to better things down the line. So, I would say those three things would be the advice that I would give anyone coming into this industry in the early parts of their career.
Stewart: It's really sound advice. I mean, T. Rowe Price has been a client of ours for quite a while, and I've had the opportunity to work with a wide spectrum of folks there, and to a person, the be kind, and the culture there is terrific. I think not only you, but I think as a firm, you guys definitely walk the talk, you really do. I appreciate you coming on, thanks for giving me a really good understanding of impact investing, and the ins and outs of green bonds, and how to make it work. And thanks for taking the time.
Matt: I appreciate it Stewart. Thanks for having me.
Stewart: It was my pleasure. Matt Lawton is the portfolio manager to the Fixed Income Division at T. Rowe Price. He manages Global Impact Credit Strategy and co-manages the US Investment Grade Corporate Bond Strategy. If you want to know more about Matt and this topic, you can see the T. Rowe Price member page on our website at insuranceAUM.com. If you have ideas for podcast, please email me at podcast@insuranceaum.com. My name's Stewart Foley and this is the Insurance AUM Journal podcast.
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