18 February 2020
Scarves don’t usually tell such a clear story...
When Larry Fink (BlackRock’s CEO) sat down for an interview with Bloomberg in Davos earlier this year, his scarf had already broadcast his message before he uttered a word. The pattern of blue and red stripes on his fashion accessory was actually a representation of the increasing global temperatures year by year.
The implicit message, which had been earlier made explicit in his influential letter to CEOs, was clear: sustainability is moving to the centre of how we invest. Investors, and the industry that serves them, have a role to play in addressing big global challenges, like climate change. The big question, once all the private jets were long departed from the Swiss resort, is how exactly can investors do that, while still meeting their investment objectives and fiduciary responsibilities.
Equity, and real asset investments usually get discussed but here we look at fixed income, which is often overlooked (our Responsible Investment Survey covers all these asset classes and more), so in this piece we're digging in to an area that has quietly grown pretty significant: Green Bonds.
You might not realise it but almost $300bn of green bonds were issued last year - that’s a lot by any stretch, for example it exceeds the total annual issuance in the UK corporate bond market, and it’s enough to finance all the renewable energy investment that took place in the world last year (although it’s still a smallish fraction of the total global bond market which issues an equivalent amount about every two weeks). Estimates for the total capital financing required for a global renewable energy transition are generally huge, and it looks likely that green bonds can play a role - perhaps providing 10-20% of that total, based on some estimates.
Green bonds have been around since 2007, when a group of Swedish pension funds looking to finance climate-related projects approached the World Bank who issued the first such bond. Since then, European governments, companies, and state-owned development banks such as KfW in Germany have tended to be the bigger issuers of these green bonds, which hinge on the proceeds being earmarked for 'green' projects. For example the recent National Grid bond was earmarked for electricity transmission projects with an environmental benefit.
One snag has been a lack of consensus on the definition of what a green project really means. You might think that would be pretty clear but there’s been more than a little stretching of credibility in the past to get to a green rating. I know right, the world’s burning and people are arguing over definitions? Well, I’ll spare you all the details but there’s good news: various initiatives are afoot, most notably by the EU to come up with a science-backed definition of green projects that ought to put an end to those issues, provided it’s adopted more widely.
Are green bonds a good investment and how can investors get access to them?
Green bonds have to date been issued by a relatively small pool of higher quality (safer) companies and quasi-government organisations, with a bias toward Europe. This means they are relatively safe, but also likely to offer less return (they have lower yields) than conventional bonds. Surprisingly perhaps, it turns out that in Europe, demand for green bonds is high, so the price tends to be slightly higher than a comparable conventional bond (and the yield to the investor lower).
This has become known as the green premium or 'greenium' and in Europe can be seen in terms of a lower average yield by anywhere from 0.1%-0.45% at issue, depending on credit rating. This also makes the capital cheaper from the issuer’s perspective, giving companies an incentive to issue green. Interestingly, this doesn’t seem to hold true in the US.
Creating a green bond portfolio - passive and active approaches are available:
There are a range of green bond indices available which would support a passive approach. However, as with all market-weighted bond indices, this concentrates exposure to those that lend the most (which we wouldn’t typically recommend for bond investing) although in the case of green bonds this concentration is also to those that are doing the most good.
There are practical difficulties involved with index trackers in that, since the green bond universe is smaller and contains some very large bond issues, the characteristics of indices can change considerably as specific bond issues are included and mature (this increases rebalancing costs for index trackers). The passive index-tracking pooled fund approach is currently available through big ETF providers such as BlackRock and Lyxor.
Buy-and-maintain or active portfolios are another option, although the number of funds remains fairly small. Here a fund manager will have more control over what type of project the bonds will be financing. Fund managers with a presence in this space include Amundi, which collaborated with the World Bank to launch a large emerging-market focussed fund, Allianz, who have a global bond product and NN with a European bond product.
Other bond funds with 'sustainable' or 'responsible' labels (eg offerings from BMO or Alliance Bernstein) have a high minimum allocation in green bonds, but are not limited to that opportunity set. Interestingly we’re seeing some funds with broader credit investment mandates starting to invest in green bond issues such as Aviva Investors’ private European corporate debt fund, and Lazard’s Global Core Plus credit strategy which has 20% in green bonds. At present northern European institutional investors tend to dominate the investor base in the active green bond funds.
Whatever your views on Fink’s sartorial choices, we live in a world of investors asking for green choices as much as consumers do. When asked what had prompted the big sustainability push within BlackRock Fink cited demand from BlackRock’s clients. Green bonds won’t be for everyone, but by allowing companies to raise capital, invest in projects, and pay a return to investors, they look set to provide a market-driven solution to addressing some of society’s big global challenges.