How Altius invest in a structurally undersupplied portion of the market

Imagine trying to sell something and having more than three times as many buyers as you have products. This isn't just a fantasy—it recently happened when the Australian government issued $7 billion worth of green bonds. The demand for these bonds was $22 billion.

For the uninitiated, green bonds are bonds used to finance new and existing projects associated with climate change and other environmental benefits. Think projects to enhance solar power and battery storage for energy, or construction of a hydroelectric power station. They follow the same structure and credit quality as other bonds an institution may issue, but with a green element.

The Australian green bond market is a burgeoning part of the credit space, with high demand and not a huge volume of supply. According to Bloomberg, sustainable bond issuance topped more than $1tr in 2023 alone, while the significantly smaller Australian market has raised $63 billion in green bonds since 2017.

The volume of demand suggests opportunity, but green investing has also been fraught with concerns, greenwashing prominent amongst them.

In this episode of Rapid Fire, I spoke to Gavin Goodhand, Senior Portfolio Manager and Co-founder, along with Kirsten Lee, Head of Credit Research for Altius Asset Management on what they are seeing across the market and their approach to green bonds. We also discussed how Altius are investing for the positive cycle they see in 2025.

What are the three biggest macro concerns you’re monitoring in the portfolio?

Gavin: The biggest macro theme is clearly inflation. Inflation has been a lot more sticky than people had expected and that has impacted the market’s views on when central banks will pivot to an easing cycle.

This impacts other areas, in particular, the consumer. I’ve been surprised by how resilient the housing market and bank arrears have been in the face of high interest rates while consumer demand has been weak. Easier policy should be supportive of the consumer and the economy in 2025.

The other big theme for us is the US election this year. We have a focus on sustainability and are monitoring the impact from a climate perspective. Trump has stated his views on climate numerous times and the last time he was in power, he stepped away from the Paris agreement. It will be interesting to see whether that occurs again. Also important will be the different fiscal and policy stance that Trump will take compared to Biden and the impact on inflation and the economy.

In light of these concerns are you veering towards floating rates or locking in fixed rates to pre-empt cuts?

Gavin: 2025 should see the commencement of an easing cycle in Australia. We're positioning our portfolio for a large cycle. Even if the RBA steps in again, we don’t think it will be an extended cycle. Next year for us will be about the easing of interest rates and our best guess on timing would be around Q3.

Credit markets should do reasonably well in that environment. An easing policy helps corporates from a balance sheet and credit profile point of view. 

You should also start to see the consumer come back and spending improve. It will take time to play through, but we expect this to be a positive for the economy.

Which areas of credit are you favouring?

Gavin: We’re seeing continued value in the Residential Mortgage-Backed Securities (RMBS) market, in particular, the higher tranches. Record amount of issuance this year has meant spreads are lagging other areas of the credit market. Then, slightly off the credit market, the semi-government space has been under a lot of pressure and the margins have widened over the last 12 months. We see value even though semi-governments supply will stay high into 2025 due to high infrastructure spending.

There’s been discussion of growing arrears in the mortgage space. Are you concerned about that when investing in the RMBS market?

Gavin: When you look at the RMBS space, arrears are picking up from historically low levels – but they are still very low. We’re consistently monitoring it, but it’s not a reason to avoid the space.

Turning to your ESG focus. What is one thing you’d like investors to understand about investing with an ESG lens?

Kirsten: Beyond supporting a just transition to avoid the worst impacts of climate change, ESG investing is also important in helping to mitigate climate-related financial risk and to manage the downside risk of an investment. This approach supports a portfolio to better manage potential uncertainty and market fluctuations. As ESG disclosures improve, it is possible to find value in ESG investing along with a strong ESG framework and a good research process.

How do you incorporate ESG principles into your approach to credit investing speaking?

Kirsten: ESG is a key focus at Altius. We have a framework around our sustainable fund, along with a sustainability committee that comprises internal and external market participants to oversee the fund and monitor investments. When we meet with an issuer, it’s very important for us to have a granular understanding about the company’s ESG commitment, even if we’re not talking to them about a green bond. 

We integrate ESG risks in our credit research process which assesses future credit risk of the qualitative and quantitative factors that could affect the creditworthiness of an issuer. Some examples of this would be analysing gaps in regulatory oversight and an entity’s lack of recognition of the financial risk of climate change.

Having a clear understanding of how a company is approaching its decarbonisation pathway and managing transition risk is important, as well as evaluating the structure of its future cash flows and impact to credit profile. We want to ensure the companies we invest in have appropriate strategies and risk management practices in place to manage and respond to material credit and ESG-related risks.

We also employ active engagement to try to address ESG risks.

Altius invests in green bonds. What do investors need to know about this space?

Kirsten: Green bonds have been making the largest contribution to the ESG-labelled bond market. There are clear reasons for that. 

They have a clear structure and there’s a bridge between that capital outlay and a project that has a good outcome for the environment and society.

It fulfils that transparency criteria we want to see in an investment.

Can you share an overview of the market and the outlook for investing in this space?

Gavin: The green market has really rebounded globally. We’re up around 25% in volume compared to Q1 2023. Europe is still the biggest market for green bonds. The US has also been a positive this year, and that’s following a dismal 2023 given the anti-ESG rhetoric that the Republicans were pushing and people backing away from that space which has settled down quite a bit.

The other positive is the Federal Government issued its first green bond as part of its sustainable finance agenda. The transaction was launched at the beginning of June 2024, they printed $7 billion and it was subscribed to the tune of more than $22 billion. There’s also been expansion in the corporate space in recent years. 

An important factor when looking at the green bond market is to assess the alignment between a company's corporate strategy and its sustainable framework.

You don’t want an entity to issue into this space just to improve their climate credentials, you want to see credibility.

Kirsten: There are a number of factors that can underpin that growth. The increasing adoption of sustainable taxonomies and transparency initiatives may support it, though the uncertainty of interest rates and wider economics could slow down issuance. 

The growing urgency to meet climate targets and continuing demand are likely to be tailwinds for green bonds and we expect continued growth up to 2030.

Can you share an example of a green bond that you’ve invested in and how it performed?

Kirsten: SA Power Networks contributed directly to the development and transformation of the energy grid and is considered the leading distribution network in Australia in terms of driving the energy transition. Most of the network can be CBI certified and that shows continued commitment to ESG. That was a good investment for us.

The most interesting thing you’ve learnt about investing in credit over your career?

Gavin: Expect the unexpected. Having worked in markets for over 30 years, it's always something from left field that catches the market off guard that leads to disruptive pricing. Often it's not the thing the market is highly focused on that leads to a market shock. Great examples are the GFC and European Sovereign crisis.

Kirsten: Credit investing is not solely about investing in credits that have solid credit profiles, it's about careful portfolio construction and balancing the asymmetric risks associated with credit. It's very different to equities.