Sovereign bond investors can align their emerging markets portfolios with global biodiversity goals without taking a financial hit.
That’s according to research published today by the Anthropocene Fixed Income Institute (AFII).
A new paper explores how lenders could encourage government borrowers to better protect natural habitats by linking progress to their cost of capital.
Using data on land and marine protection, the analysis optimises sovereign bond portfolios to align them with the Global Biodiversity Framework’s (GBF) ‘30x30’ target.
Agreed in 2022, and backed by governments all over the world, the target aims to protect 30% of the earth’s land and sea by the end of the decade.
“Our first piece of analysis looked at a developed market index,” explained Josephine Richardson, AFII’s head of research.
“But because, at the time, the US protected an area well below the 30% target from the GBF, it required a material change to the risk profile in order to achieve a portfolio level of protection close to that targeted level.”
Richardson said AFII had notably different results when applying the process to the JP Morgan Government Bond Index for Emerging Markets.
“We found you could get to nearly 28% of protected space – compared to 15% for the benchmark – while maintaining the same aggregate yield and duration as the benchmark,” she explained.
“So you can basically align your portfolio to the 30x30 goal without compromising on the duration and risk.”
Richardson told IPE the findings have significant implications for responsible investors’ ability to create differentiated demand for sovereign debt in order to protect the natural world.
If the approach was widely adopted, she said, “it has the potential to change the cost of capital [because] emerging-markets sovereigns will see that being better aligned with GBF 30x30 will get them more investment”.
The research was part of a paper exploring the interplay between bond portfolios and deforestation, published ahead of COP30 in Brazil next week, where there will be a heavy focus on the role of rainforests and nature in meeting the goals of the Paris Agreement.
“Investor strategies to address deforestation are often focused on individual engagements on high-profile names,” said Richardson.
“We’re trying to show that it can be done through a more systematic, portfolio-level approach.”
The research includes what AFII describes as a “comprehensive” universe of corporate issuers with exposure to deforestation risk.
“Being included means you have some deforestation exposure, and not being included means you don’t,” Richardson said. “So it’s a clear boundary you can apply to a portfolio – not just a list of priority companies or regions.”
The paper compares portfolios on their exposure to deforestation, explores how laws such as the EU’s incoming deforestation regulation could impact the pricing of bonds, and identifies the instruments being developed to help investors allocate capital to protecting and restoring the world’s forests.
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