Increasing incentives to decrease carbon emissions in corporate bonds

In our latest article, we explore two strategies for managing decarbonization efforts in corporate bond portfolios, along with the incentives they provide to corporate management. By understanding these approaches, investors can make informed decisions that not only align with their sustainability goals but are also likely to drive real-world impact.

Investors seeking to lower the carbon emissions of their portfolio should first sell off the highest emitters that do not have credible decarbonization plans. However, what should be done with those issuers that are high emitters but have credible plans? How can an investor incentivize them to follow up on their plans and become Paris aligned?

Investors with a tight active risk constraint relative to the corporate bond index may consider a lower allocation with a longer duration of corporate bonds issued by high carbon-emitting companies with credible decarbonization plans. This both lowers the carbon footprint of the overall portfolio and limits the tracking error against the regular benchmark. By supporting these companies with long-dated capital, investors can actively contribute to the energy transition while managing their portfolios relative risk. However, once the long-term bonds have been issued by the high emitter, the incentive to remain aligned with the plan is reduced – the company has already obtained the capital and doesn’t have to repay until far in the future.

Alternatively, investors can choose to decrease the duration of bonds issued by high carbon emitters with credible decarbonization plans. This approach ensures that companies are incentivized to stay on track with their sustainability commitments. If a company's actions deviate from the Paris Agreement, investors may withhold further financing, which in turn may increase the company's cost of capital. By demanding short-dated bonds, investors maintain leverage in influencing companies' alignment while minimizing long-term risks associated with stranded assets. However, managing the relative risk versus the regular benchmark becomes more challenging.

Each strategy has its advantages and considerations. Method 1 reduces tracking error, while Method 2 strengthens incentives for corporates, and is therefore most likely to lead to real-world change.

Every investor has unique preferences and goals and that is why Robeco conducts in-depth research and analysis to equip investors with the knowledge to make decisions that fit their investment needs and effectively meet their sustainability objectives. By accounting for carbon emissions and engaging with companies, investors have the power to drive change and support the transition to a low-carbon future.