Incorporating Green Into a PortfolioWilliam Sokol, Senior ETF Product ManagerJanuary 31, 2019
With green bond issuance reaching new highs and once again surpassing $160B in 2018,1 we sat down with Senior ETF Product Manager William Sokol to discuss what makes a bond “green” and how green bonds can fit within an investor’s portfolio.
What are green bonds, and what is the value proposition of green bonds?
Green bonds are like any other bond, except that they only finance environmentally friendly projects, like renewable energy, energy efficiency, mass transit, and others. They are defined by the projects they finance rather than the broader activities of the issuer, and any type of issuer can issue a green bond regardless of the issuer type or sector. They can allow investors to integrate sustainability into their portfolios without sacrificing return. In the vast majority of cases, green bond investors are not assuming the risk of the projects that are being financed, which I think is probably the most powerful value proposition of green bonds. They are backed by the full balance sheet of the issuer, rather than the cash flow of the underlying projects, so the risk/return profile is the same as a conventional bond, all else equal. For example, a green bond issued by Apple should provide a similar yield and return as a non-green Apple bond, after adjusting for factors like differences in maturity or liquidity.
Another attractive feature of green bonds relates to environmental impact. Green bonds are defined by what they finance, rather than the issuer, and investors can get data on specific projects funded by an individual bond. That helps investors quantify the impact their investment is making, with metrics such as carbon emissions reduced and water saved. There is certainly more progress to be made around measuring and reporting environmental impact, but most issuers are providing information. This transparency is another very powerful value proposition of green bond investing, especially for impact-oriented investors.
How do bonds get classified as “green”, and what is the process for determining what VanEck Vectors® Green Bond ETF (GRNB®) invests in?
Projects like solar and wind are generally pretty unambiguously green and environmentally friendly, but it can be less clear when we talk about things like certain hydroelectric projects or clean coal. When we were developing VanEck Vectors® Green Bond ETF (GRNB®), we knew that having an objective, science-based framework would be crucial, to let investors know that the bonds GRNB invests in are truly green. And we believe that you need a thorough, independent review of each bond and cannot rely on the self-labelling by green bond issuers.
To do that, we partnered with a non-governmental organization called the Climate Bonds Initiative (CBI). The CBI is the leading voice helping to mobilize the debt markets to fund climate solutions, and its framework is recognized globally by a wide range of market participants.
The CBI reviews all green bonds issued in the global market and assesses available information to establish whether the projects financed are aligned with its green bond project taxonomy. The overarching principle of this taxonomy is that the projects included must align with the objective of the Paris Agreement, which is to limit global warming to well within 2 degrees Celsius above pre-industrial levels through a rapid and dramatic reduction of greenhouse gas emissions. This taxonomy is reviewed and updated periodically to ensure that it reflects current technologies as well as the latest climate research.
If there is sufficient information available and the CBI determines that the projects are aligned with its taxonomy, the bond is eligible for GRNB’s index. If the projects are not aligned or there isn’t enough information available to make that determination, it’s not eligible. The CBI also reviews ongoing reporting after a bond is issued to monitor for any change or new information that would affect a bond’s eligibility.
Beyond this green criteria, GRNB’s index provider, S&P Dow Jones Indices, applies additional screens to remove illiquid bonds, and applies issuer caps to improve diversification. The result is a broad representation of the tradeable green bond market, and investors can have confidence that the bonds are truly green thanks to the independent review conducted by the CBI.
How are investors using GRNB in their portfolios?
First, let’s forget about the green aspect and just look at the exposure: it’s multi-sector, diversified, and high quality. It’s very much in line with an aggregate fixed income type exposure, which means it can fit neatly into a core bond portfolio. And that’s where we see most investors using GRNB – as a way to invest sustainably within the core. Yield and duration are in line with the agg, so investors can shift part of their core bond allocation to green bonds with very little impact from that perspective, while also getting sector diversification.
Another way we see investors using green bonds within a fixed income portfolio is as a risk mitigator. Climate risk is complex and not well understood, and it tends to not get priced in by the market like interest rate or credit risk. Examples of climate risk would be an energy company whose assets are primarily made up of underground oil reserves, or a municipality whose infrastructure assets are vulnerable to rising sea levels. Currently the market isn’t really distinguishing between these issuers, who are exposed to climate change, and those who are not or less so. When the market begins to price in climate risk, we would expect these issuers to underperform versus issuers who have taken steps to mitigate their climate risk.
A green bond strategy may provide investors exposure to issuers who are proactively addressing climate risk. And because you don’t currently give up yield, you can think of green bonds as a cheap or free hedge against climate risk in a portfolio.
What else should investors consider when constructing a more sustainable investment portfolio?
There’s clearly a lot of interest in environmental, social, and governance (ESG) investing as awareness grows, and the strong interest from millennials and high net worth investors is well documented. But one of the biggest barriers to wider adoption is confusion about the terms and the lack of standards and consistency among ESG investing strategies.
One thing I would emphasize is how green bonds can overcome this confusion. Remember that the defining characteristic of green bonds is the projects being financed, rather than the activities of the issuer, which is what an ESG score represents. ESG scores can vary widely between different ESG research providers because of the subjectivity involved, typically reflecting the opinion of an index provider or research firm.
We believe that green bonds can be a solution to this problem. Because they’re defined by what they finance, there is less subjectivity involved versus an assessment of the issuer’s broader business activity. They are also a more direct way of investing sustainably because they allow investors to target specific projects that have a positive environmental impact. Moreover, I would argue that they are more forward looking, because they finance projects that will have a future environmental benefit, and are not selected based on an ESG score, which is often based on backwards looking data.
For these reasons, we think green bonds provide a straightforward approach to sustainable investing, allowing investors to make a positive impact with their investment, without having to compromise on return objectives.
1Source: Climate Bonds Initiative
The Bloomberg Barclays Global Aggregate Index measures global investment grade debt from 24 local currency markets. It includes treasury, government-related, corporate, and securitized fixed-rate bonds from both developed and emerging markets issuers.
The Bloomberg Barclays US Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. This includes treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities and collateralized mortgage-backed securities.
This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
An investment in VanEck Vectors® Green Bond ETF (GRNB®) may be subject to risks which include, among others, green bonds, investing in European and emerging market issuers, foreign securities, foreign currency, credit, interest rate, high yield securities, supranational bond, government-related bond, restricted securities, securitized/asset-backed securities, financial services, utilities, market, operational, call, sampling, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Fund.
Fund shares are not individually redeemable and will be issued and redeemed at their NAV only through certain authorized broker-dealers in large, specified blocks of shares called "creation units" and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading Fund shares in the secondary market. Past performance is no guarantee of future results. Returns for actual Fund investments may differ from what is shown because of differences in timing, the amount invested, and fees and expenses.
Diversification does not assure profit nor protect against loss.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise.An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
Authored byWilliam Sokol
Senior ETF Product Manager