Bond investors must pick their moments
Unlike equities where early entry to broad secular trades captures maximum upside, bond investors tend to benefit from waiting for the investment phase and funding of growth as the trade
gathers pace. Leverage tends to peak and spreads to be at their widest (due to elevated levels of bond issuance) when a company is investing in new business opportunities that have yet to generate strong cashflows. This creates attractive entry points for investors who believe the market’s perception of a company’s risk will prove to be incorrect.
We may therefore prefer to take an underweight position in certain sectors likely to see a big pick-up in bond supply, in anticipation of increasing our holdings as the supply peaks. Other areas will benefit from a lowering of credit risks as stranded asset risks reduce or demand patterns become more predictable. In the context of increased climate-related spending, we are taking a close interest in the following areas where we expect credit dynamics to evolve.
Utilities: The most obvious beneficiary of the AJP will be the utilities sector, given the ambitious Clean Energy Standard designed to deliver carbon free electricity by 2035 and a carbon neutral economy by 2050. The emphasis on ’Clean Energy Standard’ rather than ’Renewable Portfolio Standard’ allows nuclear power generation to be in the mix, as well as wind and solar. This push for clean energy should benefit established renewable developers and nuclear operators, while the tax incentives for 20GW high voltage transmission lines will benefit transmission system operators.
Despite an absence of detail on how the fiscal boost will be implemented, we expect opportunities in the renewable-rich Midwest for companies that are developing clean energy sources and providing grid connectivity. This should also lead to greater electrification overall which, alongside increasing take-up of electric vehicles, could boost investor demand for copper and aluminium producers who supply the raw materials for wires and auto parts.
Clean hydrogen and carbon capture: President Biden’s plan to fund clean hydrogen demonstration plants at existing carbon emitting locations wherever possible should help preserve jobs in those communities and generate bipartisan support in Congress. Industrial gas companies should benefit from greater hydrogen production, while refineries may also prove to be unlikely winners if they can pivot to producing ‘blue’ hydrogen from natural gas, using carbon capture and storage, and receive enhanced tax credits.
Climate resilience: Biden proposes to make the electric grid, food systems and urban infrastructure, including hospitals and transport, more resilient to climate disaster. Buildings will be made more energy efficient with $213bn of funding to “produce, preserve and retrofit” around two million affordable and sustainable homes. A separate sum will be dedicated to building or modernising state-run schools, childcare facilities, hospitals and federal buildings, mainly through improving energy efficiency. This could benefit a broad range of sectors from utilities to building materials to engineering and technology.
Digital inclusion: Access to digital services is also part of the plan. Around $100bn has been earmarked for increasing broadband access for 30 million households, ensuring the whole country can benefit from being online. Congress also recently enacted the CHIPS (Create Helpful Incentives to Produce Semiconductors) America Act, which seeks to incentivise firms to increase domestic semiconductor manufacturing operations at a time of global chip shortages.
These two policy measures imply a range of benefits for US tech firms, though the rollout of 5G and faster broadband will not automatically boost incumbents. Nonetheless, technology remains key to economic growth and the low-carbon transition. In this context, providers of semiconductor equipment and 5G infrastructure and tech suppliers to the clean energy (smart meters, battery walls) and industrial automation (robotics, EVs) sectors may offer potential opportunities.
Conclusion
The size of the green/sustainable bond market looks set to explode under new US political leadership on climate change, and these fiscal measures will bring winners and losers. Working out which firms will benefit and when to invest in them will be central to generating long-term value for bond investors.
Kris Atkinson is Portfolio Manager of Fidelity’s Global Corporate Bond, Sustainable Reduced Carbon Bond and Global Hybrids portfolios and is Co-Manager of Fidelity Money Builder Income and Short Dated Corporate Bond strategy.
Kris joined Fidelity in 2000 as a Research Associate, became a Credit Analyst in 2001 and was promoted to a Senior Credit Analyst position in 2010. During this time he covered a variety of sectors across Investment Grade, High Yield and Emerging markets including European utilities, consumer / retail, pharmaceutical, global energy and basic materials. He became a Portfolio Manager in 2013 and is a key member of the Core Investment Grade strategy team.
Kris has an MA Economics from the University of Cambridge.
