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Owing to the popularity of environmental, social and governance (ESG) investments, some clients are asking advisors about more sophisticated sustainability strategies, including fixed income assets.
An overlooked though growing corner of the bond market might just have an answer for advisors. Enter green bonds. For advisors looking for an efficient to articulate to clients what green bonds are, this is a form of debt issued by corporations and governments to fund climate-friendly projects. Think a state selling bonds to build a wind farm.
Green bonds are potentially allure to clients not only because the asset class checks the ESG, but also because these bonds mostly carry investment-grade ratings and the yields are decent, relatively speaking. Additionally, when accessed in fund form, green bonds can add some global diversification to US-heavy bond portfolios. Plus, green bonds are highly relevant and will remain that way as more governments allocate big dollars to financing renewable energy plans.
“Financing this economic transformation will require vast amounts of capital. One recent estimate puts the average annual investment needed to achieve a net zero global economy by 2050 at $9.4 trillion. In response, public and private investors are mobilizing capital to support innovative solutions in areas such as renewable energy, green infrastructure, energy efficiency, and carbon capture,” according to Goldman Sachs Asset Management (GSAM).
Green Bonds Could Mean Green for Clients
An important, beneficial element in the green bond equation is that the asset class isn’t as ripe for controversy or criticism on par with other ESG offerings.
“We believe that the structure of green bonds has made them relatively more resilient to some of the complexities and criticisms of other ESG strategies,” according to VanEck research. “This is all the more notable, in our opinion, given the significant volatility in bond markets since the beginning of 2022. Because they only finance environmentally friendly projects, the evaluation of green bonds is more objective and straightforward versus a broader assessment of an issuer’s sustainability credentials.”
The “secret” is there are strict standards pertaining to exactly what defines a green bond thanks to help from guidelines set forth by the Climate Bond Initiative (CBI).
“The CBI has long been a leading voice in the sustainable fixed income market, and their taxonomy is based on climate science and informed by technical experts, as well as ongoing dialog with market participants,” adds VanEck. “In addition, we have observed a notable improvement in the level of disclosure provided by issuers in terms of both the level of detail provided on the projects financed, as well as an increase in the number of issuers providing estimated environmental impact figures (e.g. greenhouse gas avoided).”
Another selling point for clients is that many green bonds arrive courtesy of familiar issuers. Some of the members of the S&P Green Bond U.S. Dollar Select Index include Ford, General Motors, Pepsico, Apple and Verizon, among other well-known, blue-chip companies.
Green Bond Performance
Green bonds have had a tendency to be correlated to aggregate bond benchmarks, but due to the former’s different sector attributions, that could shift over time. Plus, green bonds can offer clients other benefits.
“However, longer-term we believe this provides a strong case for including green bonds within a core bond portfolio, especially at today’s higher yields. From a yield, duration and quality perspective, an allocation to USD-denominated green bonds does not have a major impact on overall risk and return. At the same time, investors may benefit from more diversified sector exposure and a tilt towards issuers who are proactively addressing sustainability in their operating plans and strategies,” concludes VanEck.