PAUL MURDOCK: Green bond issuance is on the rise in markets around the globe. While supernationals like the World Bank may have been the initial driving force behind green bonds, an uptick in issuance by corporations and agencies is helping green bonds go mainstream. Hello, I’m Paul Murdock, and joining me today to discuss the rise of green bonds are Kevin Horan, Director of Fixed Income at S&P Dow Jones Indices, and William Sokol, Senior ETF Product Manager at VanEck. Kevin, Bill, thanks for being here today.
KEVIN HORAN: Thanks for having me.
WILLIAM SOKOL: Thanks for having us.
MURDOCK: Kevin, to start, how large is the global green bond market today and how fast is it growing?
HORAN: Well, Paul, that’s a great question. We work with the Climate Bonds Initiative [CBI] and, according to them, there’s $700 billion in green bonds outstanding, and $200 billion of those were just issued in 2019.
MURDOCK: So, Kevin, how do our indices then go about measuring the global green bond market?
HORAN: Well, Paul, we’ve developed a series of indices that capture the green universe based on the CBI taxonomy. When we originally issued the index back in 2014, it included 118 bonds with a market value of $35 billion. Now, forward to today, it currently makes up just under 6,000 securities with a market value of $550 billion. Of that $550 billion, if you look at the issuer countries, the leading issuers are the U.S., France and China. France has a sovereign bond issue with a maturity of 2039 that they’ve continued to tap and will in the future.
When you look at the ratings aspect of the index, it has gone from the historically large supernational issuers of AAA to where it’s more diversified and you’ve gotten corporate issuers, both financial and non-financial, as well as the sovereign issuers, depending on their country rating, filling out the ranks. So, BBB, a component of the index, has seen the largest growth, but that is also followed by the A and AA, where those respective ratings buckets fill in about 20% each of the index.
MURDOCK: Thanks, Kevin. Bill, VanEck recently made a switch to the S&P Green Bond USD Select Index. Can you walk us through what’s the importance of an underlying benchmark index? And, then, how has that switch helped sharpen the strategy that VanEck created that tracks this index?
SOKOL: Sure. We think that with any index, especially one that an ETF tracks, you want the index to be investible and provide diversified exposure to an asset class, and do so in a transparent, rules-based way. With green bonds, an additional consideration is making sure that the bonds that are included are truly green, and a unique feature of the S&P Green Bond suite of indices is that bonds need to be designated as green by the Climate Bonds Initiative. The CBI ensures that the projects being financed by the bonds align with their taxonomy, which is a vetted list of project types developed by climate scientists that align with the goals of the Paris Agreement.
This framework is transparent. It allows a consistent assessment across green bonds in an objective way. Our previous benchmark, the S&P Green Bond Select Index, satisfied all these criteria, but it was a very global index, with about 65% denominated in euros. That market’s been characterized by very low or negative interest rates in recent years, and we found that U.S. dollar-based investors had difficulty justifying the currency risk they’re taking given those low yields, even if they found the green aspect very appealing. Fortunately, with the growth of the overall market, the U.S. dollar subset of the market has also grown tremendously, and you can now build a liquid, diverse green bond portfolio without the currency risk and without sacrificing yield. And so that’s why we decided to switch the benchmark on our green bond strategy to the S&P Green Bond USD Select Index.
MURDOCK: So, Bill, where do green bonds tend to fit in a portfolio context, and, historically, what types of investors have used them and how are they implemented?
SOKOL: Well, we’ve seen green bonds being used by a wide variety of investors. Since the market’s inception, institutional investors have really driven the market and have made significant allocations into green bonds. But we’ve also seen increasing interest among advisors and individual investors as well. In general, all investor types are usinggreen bonds in a similar way, which is within their core bond allocation. Green bonds provide high-quality exposure to a mix of government, corporate and agency issuers, and you can allocate into green bonds without significantly impacting your yield or duration profile, versus a U.S. aggregate bond benchmark. So you can build a sustainable bond portfolio without sacrificing yield and without having to take on additional interest rate, credit or currency risk, while also adding diversification to your core bond allocation.
MURDOCK: I know there’s been increased demand in the market recently. Can you describe what are some of the factors that are driving this uptick in demand?
SOKOL: Well, I think the primary driver has been increased awareness that investing sustainably can lead to better long-term investment outcomes. There has been a perception that sustainable investing means sacrificing return, but there’s mounting evidence that that’s not the case, and the fact that there’s no yield give-up with green bonds versus conventional bonds, I think, provides further support to that. I think investors are also increasingly looking at ESG [environmental, social and governance] generally, not as a niche part of their portfolio, but as an overlay that they can apply to their entire portfolio across asset classes to identify opportunities and risks that are not apparent through traditional financial analysis.
In terms of risk, an emerging risk that I think is increasingly on investors’ minds is climate risk. That can include the physical risk to an issuer’s assets and operations and also the risk that comes through the transition to a low-carbon economy, perhaps through changes in government policy. A lot of investors are using green bonds within their bond portfolios as a low-cost hedge against climate risk, because they provide exposure to a diverse set of issuers who are proactively investing in climate solutions. And, of course, investors can access these issuers without sacrificing yield.
And lastly, I think another driver of increased demand is coming from the impact perspective. Green bonds and green bond issuers provide reporting and transparency on the projects being financed and provide estimates of the environmental impact that those projects can have, so investors know that they’re having a direct and measurable impact with their green bond investment.
MURDOCK: Great. Bill, Kevin, thanks so much. Lots to consider in the global green bond market.
HORAN: Thank you for having us, Paul.
MURDOCK: To learn more about how indexing works for green bonds and across the ESG spectrum, visit spdji.com. Thanks and have a great day.
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