One of the fastest growing segments of the fixed income market is also one of its greenest.
Green bonds, which finance everything from infrastructure improvements to mass transit to renewable energy projects and energy-efficiency initiatives, saw about $81 billion in corporate, municipal and sovereign issuances last year, according to the Climate Bonds Initiative (CBI), and are estimated to be $130 billion in 2017.
Indeed, Bloomberg notes that while green bonds are still a small fraction of the overall debt market, their issuance has grown dramatically; the Climate Bonds Initiative reported a record $56 billion of green bonds was issued during the first six months of 2017.
Citing HSBC analysts, the news service said that “evidence is mounting that bonds that finance environmental projects perform better than conventional ones,” noting that green bonds trade closer to benchmarks than regular debt issued by the same entity. “There is value in green bonds for bond investors…the conclusions are likely to cheer supporters of responsible investing, who say that investors can do good and generate healthy returns at the same time.”
Before entering the space, however, investors and their advisors should understand the nuances of this emerging fixed income sector, as new issuers are coming to market with a variety of innovative products. And while it’s quickly getting crowded, here are five important things to know:
1. A ‘Green’ Definition
The momentum of continued green bond issuance and market demand has led to growing consensus on what constitutes a green bond. Put simply, green bonds are just as described—those created to fund projects that have positive environmental and/or climate benefits, CBI notes. Green bonds are generally defined by the use of proceeds being green or sustainable projects, not by the sources of repayment, which are often identical to non-green bonds from the same issuers. It should also be noted that individual investors may also have strong convictions against investing in some bonds issued that are considered to be green, e.g., bonds issued to finance nuclear and/or hydroelectric power projects.
2. Buyer Beware
While investor enthusiasm for green bonds has grown, the fundamentals of bond investing still apply. And just because a green bond is issued for good purpose—or the company issuing it is a sustainable business—it doesn’t always mean that it will be good for a particular investor’s portfolio.
Investors should remove any “rose-colored glasses” that too often accompanies green investing and look at the fundamentals—credit quality, financial stability, yield and other factors—when selecting a green bond, just as they would (or should) with any other sector.
3. Shades Of Green
As the market for green bonds grows, investors should use common sense when evaluating product for the development of a green portfolio.
In addition to green-certified bonds specifically (from the CBI and other organizations), advisors and their clients can build quality portfolios with bonds that offer a sustainable, environmental benefit, even though they’re not technically certified as “green.”
Examples include public transit, water and sewer systems, municipal recycling initiatives and similar products and services.
A slightly lighter shade of green for bond investors are those that “do no harm,” including fixed-income investments in education, housing and other investments earmarked for the public good.
One point of interest is the issuance of a green bond earlier this year from oil and gas giant Repsol, which drew both praise and consternation from industry watchers, the latter concerned it was a case of “green washing” or the practice of garnering positive PR without actually engaging in green practices. Repsol is a traditional oil and gas producer that claims the bond is green because it will save 1.2 million tons per year of carbon dioxide through improved efficiency of their operations. In spite of the tangible savings in carbon emissions, the bonds were left out of the primary green bond indices as the bonds were viewed as extending the life of the company’s fossil-fuel assets. Whether or not this is “green washing”, it’s another example of the shades of green that exist.
4. Don’t Fence Me In
Some issuers engage in what’s known as “green fencing,” in which a sliver of an issuance is dedicated to green investment, while the rest of the portfolio’s investments may be unrelated—and not necessarily sustainable.
For example, a power company might simultaneously issue multiple bonds, one that finances wind and solar power generation initiatives, and another that finances traditional fossil fuel based power generation projects.
Given a choice, it might make sense to invest in more pure play green bonds, but each investor’s wants, needs and requirement are different, requiring the flexibility that green fencing can provide.
5. Green AAPL
Some of the best, brightest (and biggest) understand the demand for green bonds.
In 2016, Apple issued $1.5 billion in bonds dedicated to financing clean energy projects across its global business operations, the largest green bond to be issued by a U.S. corporation. As with other issuances in order to
Apple’s participation brought visibility and validation to both the sector and Apple itself, so much so that the company issued a second green bond of $1 billion in June of this year.
While still somewhat new to the fixed-income space, green bonds are proving themselves adept at delivering reasonable returns with equally reasonable volatility, all while encouraging sustainable and environmentally-friendly policies and practices. It’s a win-win (win) for all involved, and well worth a look from debt-oriented investors and advisors looking to further diversify their portfolios.
Bill Mock is the lead member of the portfolio management team for Shelton’s Fixed Income and Money Market funds.
