Over the rapid adoption and evolution of environmental, social and governance (ESG) and other sustainable investing strategies, one of the most oft-asked questions by end users, including advisors, is when and how will these concepts come to fixed income?
While the landscape of sustainable investing strategies remains dominated by equity-based funds, issuers are scrambling to meet demand for fixed income counterparts. Data confirm that's a growth area with a void that needs to be fill.
“Flows into sustainable fixed-income funds have been growing steadily, however,” according to Morningstar. “They crossed the $2 billion threshold for the first time in the third quarter of 2020, and they have stayed above that mark since. This quarter (1Q21) marks the first time they have crossed the $2.5 billion mark.”
Some good news for advisors is that there are some established concepts in the sustainable fixed income arena that can be easily conveyed and are potentially useful to clients. Green bonds are part of that mix.
Going with Green Bonds
A basic definition of green bonds is debt issued to fund, you guessed it, renewable energy projects. Issuers include both governments and corporations. In a hypothetical example, Apple could sell $1 billion worth of bonds to finance putting solar panels on its various corporate campuses. That would be considered a green bond sale.
Conversely, a company doesn't issue green debt to finance acquisitions, buybacks, dividends or to retire old debt. With the requirement that these issues have an explicit environmentally friendly use, it's not surprising that green bonds a small percentage of the overall fixed income market – about $270 billion in new issues last year. However, with demand for unique bond and ESG strategies surging, so its green bond issuance. Data confirm as much.
“The green bond market has started off strongly this year, with issuance of over $100 billion already through mid-April, putting the market on track for another record-breaking year in terms of issuance,” says William Sokol, VanEck senior ETF product manager. “Compared to last year, the increase in corporate issuance has been notable, making up about 50% of total issuance.”
Green bonds aren't nearly as familiar to advisors and clients as say traditional corporate debt, munis or Treasuries. The encouraging element on that front is emerging regulatory frameworks aiming to make scoring more efficient while boosting transparency.
“In addition, a global policy framework is emerging that aims to enhance transparency around climate risks so that investors can identify climate risks and direct capital in a way that aligns with their own sustainability objectives,” adds Sokol. “In the U.S., the SEC has announced that it will update guidance on corporate climate risk disclosure requirements, and the European Union is implementing new sustainability risk disclosure requirements for companies and asset managers while also finalizing a green taxonomy. The outcome from greater transparency and more reliable and consistent climate-related data may be a stronger flow of capital towards green investments.”
What's In It for Clients
Green bonds shouldn't be a hard sell for clients – even those that aren't overtly clamoring for sustainable strategies.
The S&P Green Bond U.S. Dollar Select Index (SPGRUSST) is dollar-denominated basket of green bonds, 77% of which investment grade. Of that group, approximately 55% are rated AAA, AA or A. The medium duration lineup offers a 30-day SEC yield of 1.71% – better than short-term government bonds and many muni funds.
With this market growing, advisors would do well to become well-versed in this asset class because it's one many clients either are or ultimately will want exposure to.
“We believe that green bonds will be particularly attractive to a growing base of issuers and investors due to their simplicity, as well as the transparency and impact they can provide, particularly for those seeking 'darker' green investments that are aligned with a long-term, net-zero emissions global economy,” said Sokol.
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