Debt issued to back sustainable projects has gone mainstream as companies, institutions and governments rush to fund projects that lower carbon emissions. Do these bonds belong in your portfolio?
Green bonds, as they are known, have an allure for investors who embrace environmental, social and governance (ESG) principles.
The bonds finance projects such as renewable power expansions, subway system improvements, new water management systems and the construction of energy-efficient buildings – all certified as green and monitored by outside auditors.
The market is big and getting bigger: 2020′s issuance was nearly US$223-billion, according to Britain-based Climate Bonds Initiative. And the total cumulative issuance has crossed the US$1-trillion threshold.
What’s more, the market is expanding from its green core to include bonds that support investments in reducing carbon output at existing facilities, such as gas-fired power plants or oil operations that use new technology to cut emissions.
“We are now seeing the emergence of transition bonds, and that is particularly relevant to Canada because it allows issuers to raise capital to finance projects that can help them meaningfully reduce their greenhouse gas emissions, even if these are not in and of themselves green projects,” Sarah Thompson, director of sustainable finance at RBC Capital Markets, said in an interview.
And the rise of green bonds comes as investors show a growing appetite for ESG investments. Money flowing into U.S.-listed ESG exchange-traded funds (ETFs) doubled to US$27.4-billion in 2020, according to FactSet. Green bonds can be natural additions for investors who have embraced ESG stocks, and they don’t have to sacrifice performance.
“It doesn’t mean that you are leaving returns on the table. Today, these projects are gaining importance, and can provide returns that are competitive with more traditional fixed income,” Terry Dimock, chief officer, risk and execution, at National Bank Investments, said in an interview.
Since the bonds are backed by assets, their risk profiles are attractive – although assets such as forests aren’t the easiest to sell if the issuer runs into financial problems.
“It’s unclear how liquid green assets are, and so [the question is] whether they are going to provide you with more security in the case of a liquidation,” Ryan Riordan, a finance professor at the Smith School of Business at Queen’s University and director of research at the Institute for Sustainable Finance, said in an interview.
The best approach, then, for most small investors is to diversify your green bond bets through a fund that holds several different issues.
The NBI Sustainable Canadian Bond ETF launched in January, 2020, with a mandate to focus on “debt instruments designed to raise funds for projects or businesses that have a positive environmental or social impact.”
The credit ratings are high: 100 per cent of the holdings are investment grade, mostly with double-A or A ratings. The fund, which yields 2.3 per cent based on the most recent monthly payout, trades on the TSX with the ticker symbol NSCB.
For global diversification, though, you need to look at U.S.-listed funds.
The VanEck Vectors Green Bond ETF (ticker: GRNB on the New York Stock Exchange), launched in 2017, tracks the S&P Green Bond U.S. Dollar Select Index. Though 35 per cent of the assets are U.S.-based, the fund also has bonds issued by China, Germany, the Netherlands, South Korea, India and many others. Canada’s weighting in the fund is just 1.5 per cent.
The average yield for bonds in the funds recently is 1.55 per cent, which is slightly higher than the 1.16 per cent yield on the Bloomberg Barclays U.S. Aggregate Bond Index.
“Investors themselves are saying they don’t want to pay up to buy a green bond compared to a non-green bond. They don’t want to accept a lower interest rate,” said Andrew Lin, managing director, infrastructure, power and utilities, at DBRS Morningstar.
The iShares Global Green Bond ETF (BGRN on Nasdaq), launched in 2018, tracks the Bloomberg Barclays MSCI Global Green Bond Select Index, with a different geographical breakdown than the VanEck fund: France is the top-weighted country, at more than 23 per cent, while the United States sits at about 10 per cent. Canada has a 3.4-per-cent weighting.
The total 12-month return, as of Nov. 30, is 5.7 per cent. Not bad, and it’s all green.
With a report from Jeffrey Jones
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