Ethical investors have begun to discover that green is not the only colour when it comes to buying bonds.

The green bond market has boomed in the past decade but now a host of other financial products have begun to emerge, promising to tackle social issues including homelessness, access to education, clean water, crime prevention and helping disadvantaged children.

Their advent sets investors the challenge of distinguishing true effectiveness from mere marketing spiel and has prompted a flurry of standard-setting efforts.

The market is still small — just $3.5bn of social bonds were issued in the second quarter of 2017, according to figures from data provider Dealogic — but this was the best quarter on record and more than double the previous record.

The trend is part of a wider shift by bond investors to follow in the footsteps of shareholders’ more longstanding efforts to push for ethical investing.

“Generational shifts of attitude, combined with transparency and increased choice of investment products, mean that people are able to better express their personal views [when investing],” says Lee Cumbes, head of public sector debt Emea, at Barclays, who has advised various social bond issuers.

“People are increasingly aware of their power as consumers, with unprecedented access to information and new dynamics in building movements of belief.”

The trend is being driven by clients of institutional investors such as pension funds and insurance companies, who want to know their money is being used for ethical purposes. Insurer Swiss Re recently shifted its $130bn investment portfolio on to ethical benchmarks.

For issuers, the attraction is clear: the social label gives them the ability to reach new investors.

Dutch state-owned bank NWB issued the biggest social bond to date in May this year, raising $2.2bn to lend to affordable housing projects.

Using the social bond structure gave NWB access to a new group of investors who had not previously backed its bonds, says Tom Meuwissen, its general manager, treasury.

“We definitely would not have been able to raise as much money at such good pricing without the social bond label,” he says.

That label also comes at a cost, however. The bonds must perform socially as well as financially.

NWB had to set up a financial monitoring system and lending framework that kept track of the bond proceeds and explained to investors what it would do with them. The bank will also report back to investors on the projects it has funded each year and their performance.

The need to measure and report performance data means that some longstanding social bond investors have set up their own assessment processes.

Investment manager Rathbones’ Ethical Bond Fund has been running for 15 years — long before the label was widely recognised — and has a team who identify investment opportunities and monitor social impact once the bond has been issued. Rathbones also manages institutional social portfolios, including Big Society Capital, an independent investment fund set up by David Cameron, then UK prime minister, to pioneer social finance.

Bryn Jones, the fund’s manager, said that, as the social bond label becomes more popular investors will need to apply caution in placing their money.

“A lot of big [fund management] players are coming into the market now but there is a risk here of what you could call greenwashing, or green-stamping, or impact-washing,” he says. “Some people want to have an impact as well as being ethical, whereas other people are focused on which credit is more ethical than another within a certain sector. They will choose between BP or Shell, for example, or between Glaxo and AstraZeneca — whereas we wouldn’t hold either.”

As the market for socially beneficial finance grows, so does demand from investors for greater standardisation. The International Capital Market Association last month launched a set of social bond principles which it hopes will make the market more accessible. Such frameworks “should help to build the market’s scale”, Mr Cumbes says.

Nicholas Pfaff, ICMA senior director, says “many projects can be considered social — we needed therefore to come up with a definition of a social project”.

ICMA’s definition requires issuers to fit within one of a number of broad subject areas and to identify a target population they aim to benefit.

But, he says, any set of standards should not be too prescriptive. “There will be a diversity of opinions on the buy side about what is desirable.”

In terms of scale, he is optimistic that the social bonds market could eventually exceed that of green bonds — or perhaps green bonds will come to be seen as merely one sub-set of the wider social investment market.

As Mr Jones says: “At first, when we started, investors would say, ‘why do I want to invest in this, when I am taking a risk that you are going to underperform?’.”

Now, however, that stigma has gone. “Instead people think, ‘if I can get the returns, then why wouldn’t I want the ethical side too?’.”

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