Gethana Shashitharen
Kim Crawford
- Sovereign bond investors continue to look for sustainable/regulatory aligned solutions.
- This creates a challenge for fixed income investors looking for rates exposure that also improves environmental and societal well-being, in absence of regulatory clarity
- But Multilateral Development Bank (MDB) bond performance seems to meet both goals
Meeting sustainable requirements in government bond allocations
The emphasis on integrating sustainable investment choices throughout portfolios has triggered the launch of a vast range of products and services which meet environmental, social and governance (ESG) criteria. One exception within sustainable portfolio building blocks is government bonds, where fewer solutions have been brought to market. As a potential solution, Multilateral Development Bank (MDB) Bonds have provided US Treasury-like performance, while delivering sustainability characteristics, as the chart below illustrates.
Figure 1 – Yield to Maturity Comparison of the FTSE MDB Index and the FTSE US Treasury 1-10 Years Bond Index
Source: FTSE RUSSELL, as of October 2023. Past performance is no guarantee of future results. Please see the end for important legal disclosures
The launch of dedicated bond indices within the MDB space, such as the FTSE’s Multilateral Development Bank Bond Capped Index (the FTSE MDB Index), provide a means by which investors can have direct exposure and assist with needed capital flows for sustainable development goals through ETF products.
What is an MDB?
Multilateral Development Banks are supranational financial institutions with sovereign governments as members and their purpose is to encourage economic and social development. By issuing bonds in international capital markets MDBs raise funds which are then channeled into cheaper loans which developing nations can use to facilitate a variety of projects. The provision of such funding, alongside policy assistance and technical advice, means MDBs can play a critical role in economic development and help the global economy move closer towards its sustainable development goals.
With backing from multiple sovereign governments, MDBs benefit from Preferred Creditor Status (PCS), this along with their resilient capital structure and shareholder support, translates into very low credit risk for MDB bonds. Consequently, the majority of MDB bonds are rated the highest possible rating of triple A. As such, these high-quality securities offer investors an appealing low-risk alternative to sovereign bonds, whilst reaping the positives of meaningful sustainable investing.
Example issuer:
The International Bank for Reconstruction and Development (IBRD) is one of the MDBs which is eligible for inclusion in the FTSE Multilateral Development Bank Bond Capped Index (the FTSE MDB Index). As recently as September of 2023, the IBRD committed US$150 million in loans to a project aimed at improving higher education in Senegal. Through the construction of new educational centres and provision of new teaching equipment, the project hopes to transform the country’s university system through increasing access to digital technology, improving research quality, and removing barriers to accessing higher level education.
And in August 2023, the Asian Development Bank (ADB), that is another index constituent, approved a $45 million financing package to help strengthen quality health care in 16 districts across 10 provinces in the Lao People’s Democratic Republic (Lao PDR). As for climate funding, the African Development Bank (AfDB) approved a 30-megawatt photovoltaic solar power plant project in Eritrea.
Index construction:
The FTSE MDB Index is composed of US dollar denominated debt issued by multilateral development banks. Eligibility is restricted to MDBs that are backed by the G7 countries and where the MDBs make clear mission statements that state intent to promote sustainable economic development in developing countries. Criteria on the objectives which MDBs may actively contribute to include: reducing poverty, promoting equality, improving health and education, and delivering on activities in line with the Paris Agreement. In the FTSE MDB Index, the market weight of the issuers is capped at 25%, as shown by figure 1, providing more diversified asset exposure.
Figure 2 – FTSE MDB Index Characteristics
| INDEX CONSTITUENTS | COUNT | MARKET VALUE (USD bn) | WEIGHT (%) | INDEX CREDIT RATING | YIELD TO MATURITY (%) | EFF DUR | OAS (BPS) |
|---|---|---|---|---|---|---|---|
| AFRICAN DEVELOPMENT BANK | 5 | 9.67 | 6.7 | AAA | 4.97 | 2.97 | 13.16 |
| ASIAN DEVELOPMENT BANK | 28 | 35.96 | 25 | AAA | 5.02 | 3.36 | 10.93 |
| EUROPEAN BANK FOR RECON & DEV | 4 | 8.88 | 6.2 | AAA | 5.2 | 2.5 | 22.92 |
| INTER-AMERICAN DEVELOPMENT BANK | 19 | 35.96 | 25 | AAA | 4.98 | 3.65 | 11.65 |
| INTERNATIONAL BANK FOR RECON & DEV | 26 | 35.96 | 25 | AAA | 4.98 | 3.78 | 11.04 |
| INTERNATIONAL DEVELOPMENT ASSOCI | 4 | 6.03 | 4.2 | AAA | 5.05 | 3.53 | 19.2 |
| INTERNATIONAL FINANCE CORP | 7 | 11.38 | 7.9 | AAA | 5.1 | 2.63 | 9.28 |
| FTSE MDB INDEX | 93 | 143.83 | 100 | AAA | 5.01 | 3.41 | 12.24 |
Source: FTSE RUSSELL, as of 1st October 2023
In addition to eligibility based on engagement by MDBs in sustainable economic development projects, the FTSE MDB Index also requires issuers to have additional disclosures of safeguarding policies in place to alleviate environmental and social risks arising from their projects. Furthermore, FTSE used Sustainalytics’ Global Standard Screening to assess company compliance with relevant international norms and removes non-compliant issuers.
Investment rationale & index characteristics
From a performance perspective, analysis shows that the FTSE MDB index has very similar risk/return characteristics to investing in US Treasuries 1-10 years, but with the added benefit of improving the lives of those in emerging economies. Comparing the yield of the FTSE Multilateral Development Bank to the US Treasury 1-10 years, as per figure 1, shows that the index yields sit on-top of each other, implying that there is no yield trade-off (ignoring liquidity) and the FTSE MDB Index may be suitable for investors looking to implement an ESG Risk-off investment strategy. This is further enforced by figure 2, which shows the FTSE MDB index has an effective duration of 3.4 years and yield of 5%.
Despite the increasing demand in sustainable related funds, investors are often met by struggles with the trade-off between risk and return and sustainable objectives. In the case of MDB bond indices, both objectives are achievable.
Disclaimer
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