Morningstar - Q2 2021 - 15

Green Bonds Deliver
Impact Return
Investors can help
finance the transition
to a net-zero economy.

SUSTAINABILITY MATTERS

Jon Hale

The rapid rise of sustainable investing has
mostly taken place in the global equity markets,
but fixed income may be where the action is
in the future. With trillions of investment dollars
needed to finance the transition to a net-zero
economy, bonds will play a big role in the world's
effort to combat climate change. In fact, that
has already started to happen, as the cumulative
issuance of green bonds globally reached
$1 trillion in late 2020. Just a decade old, the
green-bond market is now comparable in size to
the high-yield market. Many observers expect
green-bond issuance this year will be in the
$300 billion to $500 billion range, with governments
and public companies refocusing on fighting
climate change as the world recovers from the
COVID-19 pandemic.
While sustainable equity funds available to U.S.
investors attracted $45 billion in net flows last year,
sustainable fixed-income funds drew only
$6 billion. But sustainable-bond funds are likely to
become more attractive to investors seeking to
generate positive impact alongside financial
returns. That's because sustainable-bond investing
focuses more on the activities financed by
bond issues rather than only on the environmental,
social, and governance credentials of issuers.
What Are Green Bonds?
Green bonds are issued by governments and
public companies to finance projects that mitigate
climate change, mostly in the areas of
renewable energy, energy efficiency, green

buildings, and green transportation. Examples
abound: In the first months of 2021, Aflac AFL,
Daimler DDAIF, E.ON EONGY, and Mastercard MA
were among the public companies that
issued green bonds. Italy and Spain announced
their first issuance for later this year, and
the United Kingdom is planning its first issuance
of green bonds targeted to retail investors.
Fannie Mae issued 2020's largest green bond
to finance its multifamily green mortgagebacked security program.
For a green bond to be formally labeled as such,
it must be certified as meeting a set of
standards laid out by the Climate Bonds Initiative
or the International Capital Market Association.
This is done by " second-party opinion " verifiers,
such as Sustainalytics. (Not all green bonds are
certified; investors may need to do due diligence.)
There is also a growing number of so-called
social bonds, which support projects in areas like
community development and affordable
housing, and sustainability bonds, which finance
both social and environmental activities.
From a risk perspective, green bonds are
equivalent to conventional plain-vanilla bonds
from the same issuer. Green-bond investors
generally do not assume project-specific
risk and, like holders of conventional bonds, have
recourse to the issuer's balance sheet.
What's a Greenium?
Recent academic research nonetheless
suggests the existence of a green-bond premium.
Sometimes called a greenium, there is little
evidence that it results from green bonds being
less risky than conventional bonds. A greenium
may result from investors' appetite for bonds
that reflect their sustainability preferences, their
desire to increase the flow of capital to green
projects, and possibly their perception that green
bonds are less risky. The greenium is good for
issuers, which benefit from a lower cost of capital
and from investor and stakeholder recognition
that issuers are helping mitigate climate
risk. Because green-bond investors are focused
on the use of proceeds, issuers have an
incentive to pay close attention to what is being
financed, ensuring the overall quality and
impact of the projects.

Investing in Green Bonds
Fund investors in the United States can gain
access to green bonds through sustainablebond funds; there were 74 such offerings by the
beginning of 2021. Such funds typically select
corporate bonds based on ESG evaluations
of issuers, much like many ESG equity funds. Those
that invest in more than one government issuer
may also evaluate ESG risk at the country
level, or in the case of U.S. municipal bonds, at the
subnational level. But many sustainable-bond
funds are increasing their emphasis on use of
proceeds, gradually increasing their allocations to
green, social, and sustainability bonds. They are
also producing reports for investors that detail the
collective impact of the bonds in the portfolio.

Despite the growth of the green-bond market,
only seven funds available to U.S. investors have a
primary focus on green bonds; these funds
may include social and sustainability bonds in their
portfolios. The oldest and biggest of these, at
$840 million in assets, is Calvert Green Bond CBGIX,
which launched in 2013 and lands in Morningstar's
intermediate core-plus bond category. iShares
Global Green Bond ETF BGRN, in the world
bond-USD hedged category, is the next largest at
about $200 million but hasn't hit the threeyear mark yet.
Investors can also get this kind of exposure
in 10 sustainable municipal-bond funds. AB Impact
Municipal Income ABIMX, a relative newcomer
launched in 2017, is the largest at about $425
million in assets. Group elder Calvert Responsible
Municipal Income CTTLX is close behind.
Investing in green bonds should deliver financial
returns comparable to those of funds with
conventional holdings of similar credit quality
and duration. Beyond that, green-bond funds,
including broader sustainable-bond funds, deliver
what we can call an impact return measured
by the combined effects of the projects that the
bonds in the portfolio have helped finance.
This impact return is key to getting more fixedincome fund investors on board to help finance the
transition to a net-zero economy. K
Jon Hale, Ph.D., CFA, is a director on Morningstar's ESG
strategy team.

morningstar.com/lp/magazine

http://www.morningstar.com/lp/magazine

Morningstar - Q2 2021

Table of Contents for the Digital Edition of Morningstar - Q2 2021