Green Bonds Grow Up

Bonds issued to fund environmentally friendly infrastructure projects are exciting more investor interest. 

“Impact” investors, those interested in environmental, social or governance issues, are finding increasingly fertile ground in green bonds.

Issued by global finance organizations, such as the World and Asian Development Banks and other public corporations, these debt securities directly finance projects, such as renewable energy generation via solar power installations or wind farms, that are meant to generate measurable environmental impacts alongside financial returns. 

Largely unknown before 2007, when the European Investment Bank issued its first “Climate Awareness Bond,” the market for green bonds grew to $37 billion in 2014, according to Bloomberg data, with demand outstripping supply. The World Bank alone has sold more than $8
billion in green bonds since 2008. 

This year, new green bond issuances have already exceeded $22 billion. That’s a sliver of the $80 trillion global bond market, but the segment is expanding due to rising demand for renewable energy projects and growing interest from investors keen to address the harsh realities of climate change. 

“The universe for green bonds is growing, although not as much as I’d like,” says Tom Nowak, a fee-only certified financial planner with Quantum Financial Planning in Grayslake, Ill. A specialist in ESG portfolios, Nowak says he has clients “who are waiting for more green bond choices.” 

Nowak says he recently purchased International Finance Corporation (World Bank) “Impact Notes,” a green bond option that became available to individual investors last year. The senior unsecured notes carry a “AAA” rating from Standard & Poors. 

While green bonds finance everything from public transit systems in Seattle to solar energy units from SolarCity Corp., a publicly traded manufacturer of solar power systems, one of the biggest draws of these specialized debt issues are their premium yields. Unrated SolarCity bonds yield up to 5.75 percent, for example, a welcome return over 10-year Treasury Notes, which are yielding around 2 percent. 

Unrated or lower-rated bonds carry greater risk of default, of course. Green bonds issued by global development banks are among the most sought-after issues because they often carry “AAA” credit ratings in addition to higher yields. 

The Asian Development Bank, for example, earlier this year sold 10-year notes with a spread of 0.12 percent over the comparable U.S. Treasury Note. The proceeds were used to “finance climate change adaptation projects such as those which climate-proof water, energy, transport or other urban infrastructure.”

Buying Bonds Through Funds

How to put environmentally conscious clients into these investments? While you can buy them at issue, or through a broker’s desk, that may not be the most efficient way. 

There are a handful of actively managed income funds that hold them. “A lot of the time, the bid/ask spread is wide in the ‘AAA’ rated bonds when traded in small sizes,” notes Benjamin Bailey, co-manager of the Praxis Intermediate Income Fund, which holds green bonds. “They are less liquid. For an individual investor, it’s better to go through a mutual fund.”

The $400 million Praxis Intermediate Income Fund (MIIIX) has a $100,000 minimum investment and charges 0.53 percent in annual expenses. It yields nearly 3 percent and returned 5.6 percent last year, according to Morningstar. It’s beaten the Barclays Aggregate Index over the past three-, five- and 10-year periods.

The $54 billion Calvert Green Bond Fund (CGAFX) charges 0.88 percent in annual expenses plus a 3.75 percent load. It’s yielding 1.4 percent and returned 4.9 percent in 2014, about one percentage point lower than the Barclay’s index. 

Another offering, though it does not focus exclusively on green bonds, is the $190 million Parnassus Fixed Income Fund (PRFIX), which charges 0.68 percent annually and yields 2 percent. Last year it returned 4.5 percent. 

A caution when betting on green income funds: There are several other bond funds with “environmental” or “social” in the title, but they may hold mostly U.S. mortgage-backed securities and lack any green bonds at all. The fund with the largest holding of green bonds is likely the Praxis fund, with a 17 percent-plus stake in the bonds.

As you can see, you’ll pay a premium for holding these vehicles. For larger clients, a direct purchase may be a better deal. 

Steve Schueth, president of First Affirmative Financial Network in Boulder, Colo., who mostly favors mutual funds for his clients, suggests finding a separate account manager for individuals who want to hold the bonds directly. These managers may seek minimum portfolio sizes of between $250,000 and $1 million, though.

It would be hard to build a diversified fixed-income portfolio with these bonds alone. While many of them are callable, they aren't as liquid as Treasuries. It’s a fairly small and specialized market, so a hike in interest rates will depress prices of existing issues.

There’s also the question of what constitutes a true green bond. Toyota, for example, issues bonds to finance the building of more of its Prius hybrid cars. Others may pay for affordable housing or environmentally sustainable development projects. The definitions can be fuzzy.

“What is green?” asks Schueth. “Some clients are fine with owning bonds issued by Toyota as green bonds, while others may want something ‘greener’ than that. But the green story is still important.”

What’s not in dispute is the demand for green bonds, especially as developing countries push to finance infrastructure that’s sustainable and carbon neutral, a priority around the world. “Every green bond issue has been oversubscribed by a factor of at least three,” Schueth notes.

In the fund world, demand usually spurs new products; there have been recent efforts by large banks, including Barclays and Bank of America, to create indexes around green bonds, so it’s only a matter of time before they are more widely available in low-cost, passive funds, opening up even further the fixed-income portion of clients' portfolios to sustainable investing.

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