Rising food, energy and housing prices aren’t just pocketbook issues for consumers or election fodder for politicians, they’re also social risk factors, indicators of a country’s economic health and highly important to bond investors, said Reina Berlien, head of environmental, social and governance at Brandywine Global Investment Management.
While ESG factors may not seem important to the bond market, these factors are tightly linked with economic indicators and deserve greater consideration by bond investors, she said during a session at Benefits Canada’s 2024 Defined Contribution Investment Forum.
“Sustainability matters are economic and fundamentally intuitive and important facets of bond management.”
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At their core, ESG factors are embedded in the macroeconomic themes that drive the global bond market, such as inflation, interest rates, countries’ budgets, trade, demographics, employment, the commodities market and consumption, she said. They can also drive legislation and industrial policies, such as the U.S.’s Inflation Reduction Act and Canada’s Strategic Innovation Fund.
Berlien homed in on the U.S., which she said neatly exemplifies the sustainability risks that bond investors should be factoring in. The country faces significant political gridlock and looming government shutdowns that can prevent legislators from addressing budget issues and funding important environmental and social policies. In addition, it’s one of the highest emitters in the world; its ageing population could drive fiscal challenges in the future; its cost-of-living crisis is contributing to further income inequality and the potential for civil unrest; and the upcoming election could drive economic policy in a new direction.
The IRA itself, while rooted in sustainability goals, also presents risks for bond investors to factor in, said Berlien, noting the mammoth legislation has sought to drive an America-first manufacturing and energy boom and decarbonize the economy, largely through subsidies and tax credits, which are expected to decrease the government’s revenues and have already become too expensive for the country to continue to afford.
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The cost-of-living crisis can also be a sustainability killer, she added. Fifty per cent of the world’s population is going to the polls this year and backlash to sustainable policies is growing in multiple countries as they’re perceived to hit pocketbooks, including in the U.S. where the IRA is on the ballot.
“When you think about it as a person, as an individual who’s been paying higher grocery prices, higher gasoline prices, higher rent, higher insurance, do you want to buy an [electric vehicle]? Do you want to decarbonize your economy? No, that’s not what they’re thinking about.”
Even as inflation has started to ease and central banks have begun cutting rates, consumers are still bearing the brunt of higher costs, noted Berlien.
She also highlighted some sustainable industrial policies that could be under threat, including carbon pricing and emissions trading schemes, durable goods purchasing mandates or bans (such as low- or zero-emissions vehicle mandates or bans on high-emissions forms of heating) and biodiversity and agricultural decarbonization mandates. Canada is already seeing a backlash, she added, with the country’s carbon tax under attack by the federal conservative party. And the implementation of the E.U.’s deforestation regulation was recently pushed back by a year.
“These are inflationary [policies]. We need to solve decarbonization, we need to fund the just transition, but not at the expense of prices, especially when we’re coming out of such a pernicious inflationary cycle. There’s a very real risk that comes with these policies and with this funding and inflation. As bond investors, we need to look at who’s bearing that burden and who’s funding it.”
Read more coverage of the 2024 DC Investment Forum.