It’s relatively easy to add socially responsible investments to a stock portfolio; doing so with fixed income is a little trickier.
Green bonds are a small but growing way for investors to add sustainable securities to their portfolio. Proceeds from the sale of these bonds finance environment-friendly projects, whether for renewable energy, energy efficiency, mass transit or some other use that reduces carbon emissions.
[See: 7 of the Best Socially Responsible Funds.]
These products debuted in 2007, when the World Bank and the European Investment Bank issued AAA investment-grade green bonds, according to the Climate Bonds Initiative, an international nonprofit specializing in the green bond market. The market expanded in 2013 when EDF, Bank of America and Vasakronan issued the first corporate green bonds.
Though it’s easy to lump green bonds all together, portfolio managers who use these investments say investors need to look into the bonds carefully. Green bonds have their own special set of characteristics compared with traditional socially responsible investments.
A nascent, evolving market. There’s a difference between a green bond and an investment that uses environmental, social and governance characteristics (ESG), says Patrick Drum, a Bellingham, Washington-area portfolio manager for Saturna Capital’s Sustainable Bond Fund (ticker: SEBFX) and an advisor for the United Nations Principles for Responsible Investment subcommittee on fixed income. A company may issue a green bond but not be a socially responsible company.
“It’s an important distinction,” he says. “A company that engages in strong ESG practices like Starbucks ( SBUX) is very thoughtful when considering their supply chain, gender diversity, corporate governance.” But green bonds, he says, just communicate to the investor how the money is used.
Because green bonds are still a nascent market, there are agreed principals but not yet universally accepted standards. For instance, Drum says, China’s standards differ from other countries. China issued nearly 40 percent of the green bonds last year, he says, but some of their bonds are for clean coal. Whether a bond like that will continue to retain its green status in the secondary market as the bond matures remains in question.
Or consider the green bond issued in the European market by Repsol, the Spanish oil company, to improve energy efficiency for its refineries. At the Praxis Impact Bond Fund ( MIIAX) in Goshen, Indiana, fixed-income investment managers Benjamin Bailey and Delmar King support energy efficiency but say they would have passed on this bond because improving energy efficiency at oil refineries does not reduce carbon emissions.
That doesn’t mean all energy companies are off limits. Utility Southern Co. ( SO) has issued green bonds, and although it uses coal, its independent power-producing subsidiary, Southern Power, allocates significant capital to renewable energy, for instance, by adding more solar power as the cost curve falls.
“From our perspective, the company may be more brown, but the bond itself is dark green; that’s something we want to support,” Bailey says, noting his fund owns Southern Power green bonds.
Evaluate the shades of green. That’s why investors interested in green bonds should talk with their advisors about the types of projects they want to back, says Bill Mock, San Francisco-based lead member of the portfolio management team for Shelton Capital Management’s fixed-income funds.
[See: 11 of the Best Fixed-Income Funds to Buy.]
Mock, who manages $130 million in green bond investments, says Shelton owns Apple ( AAPL) green bonds. He likes the company’s framework for conserving resources and creating greener materials.
Apple has its detractors, but Mock says the company’s credit rating was also a draw.
“It’s a company that does care,” he says. “Clearly, from a credit perspective, it would be hard for us to find a better company. And we specifically had clients who said, ‘I would like to own the Apple green bonds.'”
King and Bailey have been involved in the green bond market since its inception, and they say investors should talk to the portfolio managers about the specifics of the green bonds that a fund invests in to understand their impact. “Instead of buying something and saying, ‘I trust or believe the manager is doing everything they can,’ get some data points for it,” King says. “Ask how much carbon was removed, for instance.”
As the market grows, more third-party entities are evaluating these bonds, such as Moody’s and Standard & Poor’s, Drum says. Meanwhile, the ways to invest keep getting easier. While mutual funds are starting to add more green bonds, one exchange-traded fund — the VanEck Vectors Green Bond ( GRNB) launched earlier this year — is based on the S&P Green Bond Select Index. William Sokol, ETFs product manager at VanEck in New York, says the index relies on data from the Climate Bonds Initiative. VanEck created the ETF so it can grow as the market evolves.
Drum says extra legwork goes into evaluating these bonds because many trade at a premium thanks to their green status. He looks at the return, the entity’s commitment to third-party verification, its intention for proceed use and reporting practices so that the investment can continue to be evaluated, both financially and for its green status.
[Read: 3 Investment Strategies to Tackle Climate Change.]
Because bonds trade in the secondary market for years, integrity is paramount, he says. “If it fails to retain that green bond status, I might be stuck in an adverse position,” he says, with a brown bond that has seen its liquidity and premium evaporate.
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Do Green Bonds Belong in Your Portfolio? originally appeared on usnews.com
