Where to Find Sustainability in Bonds

One of the primary questions arising from the environmental, social and governance (ESG), impact and sustainability investing movements is when these principles will be broadly applied to bond funds.

While the vast majority of funds, be they active or passive, that check either the impact investing or sustainability boxes are equity-based products, the fact is there are signs these styles are matriculating to the fixed income space.

Quietly, the movement started several years ago – longer than that for investors outside the U.S. – with a concept still unbeknownst to many clients: Green bonds. As has been widely noted, green bonds are easy to explain to clients and a case can be made this is the ideal asset class for clients seeking sustainable investments and fixed income exposure.

The straight-forward definition of a green bond is debt issued by a corporation or government to fund an environmentally project. Advisors can and should mention to clients that while green bonds are nowhere near the size of say municipal or traditional corporate debt, this corner of the bond is growing. Rapidly.

Last year, $505 billion worth of green bonds came to market – almost double the $253 billion in bonds sold by fossil fuels companies.

2021 “was still the first since the Paris climate agreement in late 2015 that more money went into green bonds than debt issued by oil, gas and coal companies,” reports Tim Quinson for Bloomberg.

Direct Path to Sustainability

An emerging theme in ESG investing is that there's too much fluidity when it comes to ESG ratings and that's drawing scrutiny from both asset allocators and regulators.

That's part of the reason sustainability has momentum. When properly executed, a sustainable fund or index prioritizes climate-aware companies or environmentally friendly equities or bonds. With that singular focus, investing for sustainability avoids a lot of the nuance and controversies associated with traditional ESG strategies.

“Because green bonds are defined by the projects they finance rather than the broader activities of the issuer, they provide a direct and objective approach to sustainable investing, and one that is forward-looking due to the long-lived nature of most projects being financed,” says William Sokol, senior ETF product manager at VanEck.

Beyond the direct approach offered by green bonds, this method of financing is increasing preferred by issuers and underwriters, indicating there's long-term opportunity in this market.

“Green bonds are increasingly being recognized by corporations, banks and governments as an essential tool to finance climate-related and other environmental projects,” adds Sokol. “The size of the green bond market has increased significantly in recent years, and we believe issuance will scale up massively to finance the projects needed to help transition to a low carbon economy.”

Green Bonds Have Wide Audience

Broadly speaking, green bonds typically carry investment-grade ratings and a significant portion of these issues reside in intermediate-term territory – the duration category least correlated to equities.

Additionally, some green bond assets – namely the VanEck Green Bond ETF (GRNB) – are more transparent than old guard sustainability themed products, confirming the asset class meets the standards of increasingly climate-savvy clients.

“The Climate Bonds Initiative, a non-governmental organization working towards mobilizing the global debt markets for climate solutions, has developed—with the input of hundreds of technical experts—a project taxonomy that is rooted in climate science and aligned with the objectives of the Paris Agreement,” concludes Sokol. “The taxonomy identifies projects and activities needed to deliver a low carbon economy, and also identifies projects that are not aligned with this goal.

Related: These Bonds Could Be Beautiful in 2022