Morningstar - Q2 2023 - 37

EXHIBIT 1
Assets Are Climbing Sustainable-bond funds have nearly tripled their assets since
the end of 2019.
$600B
499.7
400
305.8
200
128.5
45.2
Source: Morningstar. Data as of Dec. 31, 2022.
2013
57.8
2014
55.8
2015
64.3
2016
85.4
2017
2018
2019
2020
2021
2022
179.6
516.3
a senior fixed-income portfolio manager
at Praxis Mutual Funds, which bought the issue.
To be sure, sustainability-linked bonds mean
that the issuer has full discretion over how
capital will be used once it's raised. That presents
the potential for greenwashing. Liberatore of
TIAA-CREF thinks that the targets and penalties
aren't aiming high enough. For example,
he says that he recently saw a 2021 issue with
a 2030 carbon footprint reduction goal use
its 2017 footprint as the baseline. In another case,
a bond structure included a KPI that had
already been achieved. That makes third-party
verification more useful than ever. Liberatore
prefers use-of-proceeds bonds. " The projects are
specified at issue, and the associated
outcomes can be benchmarked, measured, and
reported to investors, " he says.
" This is a great story, " says Hortense Bioy, global
director of sustainability research at Morningstar.
" If there's a space where you can measure or
deliver impact more easily, it's in bonds, because
of use of proceeds. Investors want to be able
to measure impact. "
The key flavors of sustainable bonds are green
bonds, social bonds, sustainability bonds, and
sustainability-linked bonds.
Green Bonds
These are bonds that support climate-related or
environmental projects, first issued in 2007
by the European Investment Bank and the World
Bank. The latter issued $14.4 billion worth
between 2008 and 2020. Green bonds often come
with tax advantages to attract investors. The
proceeds have supported solar and wind
installations, rehabilitation of power plants and
transmission facilities to reduce greenhouse
gas emissions, and projects to bolster efficiency
in transportation, such as fuel switching.
Social Bonds
These are used to finance public and private social
equity efforts in communities, often helping
displaced persons and those living in poverty or in
marginalized communities. One type has been
COVID-19-related bonds aiming to mitigate social
issues related to the pandemic.
Sustainability Bonds
The proceeds of these bonds finance green and
social projects or activities. They can be
secured with collateral assets, unsecured, or
backed by the creditworthiness of the corporate
or government issuer.
Sustainability-Linked Bonds
Also known as key performance indicatorlinked
bonds, or KPIs, these bonds are linked to
the issuer's achieving a sustainability metric
within a set period. Such bonds might, for
example, track a company's progress against one
of the United Nations Sustainable Development
Goals or against the Paris Agreement. If the
issuer fails to meet its goal, higher interest is paid
to investors. In 2021, issuance of sustainabilitylinked
bonds grew to $100 billion from
$9 billion in 2020.
This system commits issuers explicitly to
sustainability improvement. For example, in 2019,
Enel Group issued 2.65% bonds maturing
in 2021. Enel would pay an additional 25 basis
points if it failed to increase renewables to
55% of total generation capacity by the end
of 2021. In June 2019, Enel had 46% in renewable
generation. By the end of 2021, Enel had
57.5% of its energy from renewable sources,
according to the KPMG auditors' report.
" It's a carrot and a stick, " says Benjamin Bailey,
The 'Greenium'
Elsewhere in the sustainable-bond market,
there's room for improvement. For example, more
funds are needed. Morningstar counts
just 134 sustainable-bond funds in the U.S.
The ESG municipal-bond category counts
just 17 U.S.-domiciled strategies, for a total of
$2.1 billion in assets. This includes Calvert
Responsible Municipal Income CTTLX, the third
oldest of all sustainable fixed-income
strategies, which has less than $450 million
in assets under management.
Another challenge is that ETFs tend to be
globally oriented, with as much invested overseas
as in the U.S., says Bob Smith, president
and chief investment officer of Sage Advisory
Services in Austin, Texas, who oversees a
number of accounts that use sustainable fixedincome
funds and ETFs. That poses challenges
for U.S. investors who keep track in U.S.
dollars. Yet another challenge: Finding the right
match during demanding market periods.
After all, so much of overseeing a fixed-income
portfolio is yield-curve management-
a tough ask when the yield curve is inverted.
" There aren't a lot of choices on the long end, "
Smith says.
All these issues are causing what's called
a greenium, or a premium in sustainable bonds.
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