3-minute insight: What is the allure of impact bonds?

Mr. Rex Lo
Managing Director, Business Development of BEA Union Investment
Mr. Lo has more than 20 years of experience in the financial industry. He is responsible for the distribution strategies for retail, private banking and wealth advisory channels, as well as marketing and communication strategy in the Greater China region.

In recent years, there has been a proliferation of ESG products, including impact investing. We have invited Mr. Rex Lo, Managing Director, Business Development of BEA Union Investment to share with us the market's investment potential.

Q: What is the difference between impact investing and ESG investing?

A: Impact investing is a type of ESG investing. The difference between the two is that impact investing takes a more proactive stance, which is why it has captured the attention of investors. Some of the key highlights include:

  • Impact investing projects must be well-defined, and will result in positive, measurable social and environmental impacts
  • Have internationally recognized indicators for reference, including the United Nations' Sustainable Development Goals (SDGs), as well as principles of the International Capital Market Association
  • Regular reporting is required, including the status of projects and their measurable outcomes

All in all, the target of impact investing is to allocate funds to projects that drive "measurable" and "positive impacts" on social or environmental issues, while generating investment returns.

Q: Through what channels can investors participate in impact investing?

A: Impact investing requires professional analysis, research and an extended period of monitoring of investment projects. Investors can consider impact investing by investing in funds.

For example, impact bond funds in the market are managed by professional fund managers, who will explore bond investment opportunities with impacts and attractive returns for investors.

Q: How popular are impact bonds in Asia?

A: Backed by governments, many corporates have issued impact bonds in a bid to meet regulatory requirements and social expectations, raising funds that help to tackle green, social/environmental issues. Driven by growing supply and demand, the market is expected to expand.

For instance, the issuance of impact bonds in Hong Kong accounted for nearly 20% of the total issuance this year, with issuers spanning banks, developers and public affairs sectors.

According to the Hong Kong Monetary Authority, Hong Kong issued US$80.5 billion worth of impact bonds in 2022, including green, social, sustainability and other labelled (GSS+) bonds, representing an increase of more than 40% from the previous year.

Last year, China was one of the biggest issuers of certified climate bonds , ranking top three alongside the US and Germany in the green bond market. At the same time, South Korea's social bond issuance ranked third in the world.

Q: I already have investments in bonds. Can impact investing add value to my portfolio?

A: To issue an impact bond, the issuer needs to fulfil the aforementioned requirements pertaining to impact investing. Most of the impact bonds are issued by companies of Investment Grade. Their credit ratings are generally higher with relatively lower default risks.

Investing in impact bonds can capture the potential capital appreciation of Investment Grade bonds while participating in the drive for improving green, social or environmental issues. It is a novel investment solution that blends "financial returns and purpose".

Compared with that of the US, Asia impact bonds have more favourable yields and shorter durations, which may reduce potential volatility. Asia also enjoys better economic prospects, including robust fundamentals and relatively lower inflationary pressure.

Q: Deposit rates are hovering at relatively high levels. What is the appeal of Investment Grade impact bonds?

A: Although rates are still on the rise, the US is approaching the end of its rate hike cycle, and the magnitude and frequency of future hikes should ease eventually. As rates peak, yields will likely edge lower, prompting bond prices to rise. Bank deposit rates may be attractive now, but when the rate hike cycle ends, interest rates will fall and so will bank deposit rates.

Looking back at previous rate cycles, when rates peaked and plateaued, bond prices were already on their ascent, reflecting rate cut expectations. Between 2018 and 2019, when rates plateaued during those seven months, the cumulative gain of Asia Investment Grade bonds¹ was 9%. Bond prices extended their gains when rates subsequently trended lower.

When buying into bonds at this stage, one can lock in attractive yields, and benefit from the increase in bond prices when rates start to fall. Investors can consider positioning themselves early to capture returns from both yield and capital appreciation.

1. Source: Bloomberg, peaking rates data sourced between 19 Dec, 2018 and 30 Jul, 2019. "Asian Investment Grade bonds" is referred to ICE BofA Asian Dollar IG Corporate Index.