It was once the case that bond investors who desired both healthy returns and a positive environmental impact from their investments had relatively few choices.
Cutting carbon emissions, financing clean energy or supporting social goals often meant accepting a narrower investment universe and potentially greater risks. The more specific the goal, the greater the likelihood of the portfolio deviating significantly from the benchmark.
Today, this trade-off is becoming easier to manage.
The sustainable corporate bond universe has expanded and deepened in ways that few could have envisaged.
Corporate bonds are now a critical financing channel for the sustainable transition, providing companies with capital for a wide variety of environmental initiatives.
Take green bonds. The range of projects such securities now finance has expanded considerably - from the building of energy-efficient manufacturing systems to the integration of climate adaptation infrastructure.
What is more, these bonds carry the same credit rating as the issuer’s comparable conventional debt.
Yet the evolution of the bond market only partly explains why sustainable investors have more choices. Changes in the way portfolios are built and managed have also had a part to play.
Increasingly sophisticated portfolio construction techniques offer further flexibility, allowing investors to pursue specific objectives while maintaining a risk-return profile broadly in line with that of traditional bond indices.
Sustainability solutions, customised
As the sustainable bond market has matured, investors are gaining access to a wider range of portfolio construction options. Rather than having to default to broad ESG mandates, investors can instead incorporate any one of a growing number of sustainability priorities – whether that is reducing carbon emissions, financing climate adaptation or funding improved access to education. This can be done through targeted allocations, exclusions and issuer selection.
Some investors, for example, may choose to exclude issuers or sectors associated with activities such as coal production, weapons or gambling, while others may prefer to tilt their portfolios towards companies whose products and services solve environmental or social problems.
Crucially, investors can design portfolios that fulfil specific sustainability objectives without materially changing their overall risk profile.
For example, in response to a client request, we were able to build a Swiss franc corporate bond portfolio with a decarbonisation objective, one targeting a 5% annual reduction in the Weighted Average Carbon Intensity (WACI) relative to 2019 baseline of the Swiss Bond Index (SBI) – all while maintaining a low tracking error.WACI measures an investment portfolio's exposure to carbon-intensive companies by dividing greenhouse gas emissions by sales revenue and weighting each company by its share of the portfolio. Source: UN PRI
Investors can also pursue several sustainability goals simultaneously. Our model portfolio (Fig. 1) illustrates how an investor with an existing investment-grade corporate bond allocation can achieve multiple impact objectives, including climate mitigation, biodiversity protection and improved access to essential services, by incorporating ESG labelled bonds.https://www.pictet.com/uk/en/insights/beginner-guide-to-esg-labelled-bond
The resulting portfolio maintains minimal tracking error relative to the Bloomberg Global Aggregate Corporate bond index while delivering a similar yield.
POSITIVE SCREEN
| %Proceeds* | Impact* | Portfolio | Benchmark | ||
| NATURAL CAPITAL | ☑ Climate change mitigation | 63% | MWh renewable energy | 1,278 | 79 |
| ☐ Climate change adaptation | t CO2 avoided/ reduced | 1,060 | 43 | ||
| ☑ Water | 7% | ||||
| ☐ Biodiversity | 2% | ||||
| ☐ Resource efficiency | sq.mt of nature | 23,039 | 2,830 | ||
| HUMAN CAPITAL | ☐ Health | 3% | |||
| ☐ Education | People with access to essential services | ||||
| ☑ Livelihoods | 13% | 54 | 12 | ||
| ☐ Society | 1% |
Model portfolio, for illustrative purposes only. Benchmark figures consider the impact of the labelled bonds, which made up 5.4% of the benchmark at the time of the analysis. * Dimensions accounting for more than 5% of proceeds are ticked. **Unit: impact per EURmln invested per year. Source: Pictet Asset Management
A similar outcome is also achievable through a global investment grade corporate bond allocation. We have built a model portfolio using the Planetary Boundaries framework (Fig. 2) – a screen that allows us to identify and exclude issuers whose activities are harmful to the planet along any one of nine critical environmental dimensions.Planetary Boundaries is a globally recognised sustainability framework which defines the environmental threshold within which humanity can prosper. For more details, please read: https://am.pictet.com/ch/en/intermediaries/investment-research/planetary-boundaries-and-environmental-footprint-of-businessesApplying a range of portfolio optimisation techniques, we were able to achieve the twin objectives of maintaining a tightly controlled active risk budget and minimising the portfolio’s Planetary Boundaries score.
The resulting portfolio had a substantially lower environmental footprint than the benchmark, a similar yield and a tracking error of less than 0.5%.
NEGATIVE SCREEN
| Own operations & supply chain | Planetary Boundary Score | |
| NATURAL CAPITAL | ☑ Exclude outside Planetary Boundaries | Acidification Aerosol Biodiversity Chemical Eutrophication Land Ozone Warming Water |
Model portfolio, for illustrative purposes only. Source: Pictet Asset Management
As more institutional investors, family offices and sustainability-minded investors embrace non-financial goals, sustainable credit is becoming a mainstream asset class.
There are many other approaches investors can take to further expand the range of investment options available. The Bloomberg Cambridge University (BCam) Corporate Index, for example, is a newly created corporate bond benchmark which excludes companies engaging in or financing fossil fuel expansion.
What sets the BCam index apart is that it has an innovative feature that encourages and rewards engagement that changes corporate behaviour. It combines research-led engagement with clear criteria for index inclusion, while offering companies a route back into the index if they improve.
Institutional interest in using the index is building. The United Nations Joint Scheme Pension Fund and Cambridge University have expressed support for the BCam “fossil phase-out” index with potential allocations totalling USD 750 million to mandates tracking it. Other significant asset owners involved in its creation include the California State Teachers' Retirement System (CalSTRS), Britain's Universities Superannuation Scheme and the Swiss Federal Pension Fund PUBLICA.https://www.reuters.com/sustainability/cop/cambridge-un-pension-scheme-back-novel-climate-focused-bond-index-2025-04-11/
As more institutional investors, family offices and sustainability-minded investors embrace non-financial goals, sustainable credit is becoming a mainstream asset class. Green bonds remain the dominant label in the ESG labelled bond market, with cumulative issuance now exceeding USD 4 trillion as demand grows for instruments financing mitigation, adaptation, resilience, clean energy, low-carbon transport, green buildings, sustainable water infrastructure and other climate-aligned activities.https://www.climatebonds.net/news-events/press-room/press-releases/sustainable-debt-market-surpasses-usd7tn-aligned-issuance
The growth of sustainable fixed income is giving investors greater control over the outcomes they want their portfolios to achieve. These approaches require active investment decisions, but they no longer force investors to accept large deviations from the benchmark. As our case studies show, careful portfolio construction and optimisation techniques can help preserve diversification, maintain benchmark-like yield characteristics and reduce the risk of unintended concentrations and exposures.
