Greening Your Bond Portfolio

Coverage of the Investment Innovation Conference

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green shootsSome of the biggest pension funds in Canada have made the commitment to reduce the carbon footprint of their equity portfolios and private investments — but what about their fixed income? Erin Bigley, senior vice-president, senior portfolio manager, fixed income and responsible investment at AB, says green bonds now provide a growing set of opportunities for investors to green up their bond portfolios.

While the green bond market is still small (just $220 billion vs. Canada’s $2 trillion bond market), Bigley says it’s reached a tipping point as issuers and sovereigns alike work to reach the nancing goals set by the Paris Climate Accord.

A big challenge in this burgeoning market, however, is issuance — green bonds must be used for projects such as energy, water, pollution prevention, transit or greening buildings.
And there are additional reporting requirements — most issues are evaluated by a third-party evaluator and issuers have to track proceeds and report on impact.

That can make it a costly endeavour. So far issuers have mostly been the biggest companies, like Apple who recently issued $10 billion in green bonds to clean up its operations.

But it does make green bonds a compelling prospect for risk-averse investors. “As investors, the bonds work to our advantage — green bond buyers have the same rights as unsecured bond holders, but the proceeds are earmarked for speci c purposes,” Bigley says.

Who are the biggest issuers?

While corporates make up a large share of the market, one of the growing areas of issuance is sovereigns with the mandate and the deep pockets to issue this kind of debt.

“France has aggressive climate goals and has committed to regular green bond issuance,” she says, adding that the green bond market is dominated by Europe right now. Green bonds
are being used to fund renewable energy and cleaner transit.

Emerging markets are also shifting into this space led by China. By contrast, the U.S. is a laggard with only 10% of issuance coming from south of the border.

But there are challenges that have so far impeded greater uptake — and one of the biggest is the sheer cost of issuing green bonds. “There’s a cost to doing the extra work required to be labelled a green bond. Who pays for that extra work? Issuers pay now,” Bigley explains. “But there is a tension growing between issuers and investors.”

That makes it hard for all but the biggest companies to issue green bonds and it puts limits on where and how the universe can grow to the trillions of dollars needed to meet the targets of the Paris Accord. “Investors could accept a bit lower yield to cover the costs — but our many investors with duciary concerns can’t accept lower yields.”

While there are still challenges to be addressed, Bigley says the green bond space represents an interesting new way for investors to have an environmental impact with a bond-like framework that gives them recourse in the event things don’t go as planned.

The market right now is small, “but we need to grow bigger to nance climate goals,” Bigley adds. For investors, green bonds can play a role — they can be used as fixed income in both a matching and a total return portfolio.

Bigley does note that the de ned contribution space could be one area where green bonds make a lot of sense. “They can certainly meet the needs of younger plan members who are thinking of these issues.”

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