Bonds becoming favorite of green investors

When it comes to green investing, fixed income seems to be getting more attention than equities from institutional investors, which also like the asset class for capital preservation, diversification and downside risk management.

A survey of 80 midsize U.S. institutional investors conducted by Breckinridge Capital Advisors and Greenwich Associates found investment-grade fixed income to be the top asset class for ESG use, ahead of domestic and non-domestic equities.

At the time of the 2020 survey, 34% of the institutional investors were using ESG in their portfolios and 70% of the others were either actively considering it or might consider it.

Corporate and public pension funds made up more than half of the sample of investors with assets between $200 million and $1 billion, along with endowments, foundations and others.

"It was revealing that what was really driving a lot of the ESG is the belief that it helps as a risk mitigator," said Peter Coffin, founder and president of Breckinridge Capital Advisors. The Boston firm manages $44 billion in assets and specializes in investment-grade fixed-income portfolios.

That asset class is "a logical and relatively seamless starting point" for integrating ESG, said Andrew McCollum, managing director and head of investment management for Greenwich Associates in Boston.

ESG, Mr. Coffin said, "is in large part trying to identify external risks. The purpose of a fixed-income allocation is to preserve capital. We see ESG aligning with that objective of looking ahead and trying to gauge and assess price and risks that are long term," he said. "A pension fund would want their investment manager examining those factors when they are looking at issuers."

Part of the increased interest comes from better disclosure by companies of environmental impacts, he said. "As disclosure has improved, as investors have become more knowledgeable about ESG making an impact, I think the investment case has really taken hold," he said.

Green bonds generally refer to how the proceeds will be used, from specific environmental goals to helping companies transition to a greener outcome. Curbing climate change was the top reason that national governments issue green, social and sustainability (GSS) bonds, according to the Climate Bonds Initiative, an international organization working to develop a green and climate bond market. Those sovereign issuers also are serving as catalysts for corporate and institutional issuers, green bond advocates say.

Increasingly, it is investors who are driving interest. "Investors globally are setting out their own ESG criteria as to what matches their own goals," said Janine Dow, senior director of sustainable finance for Fitch Ratings Ltd. in London.

"Some of that is being dictated by regulation, especially in Europe, but increasingly it is voluntary as well. Consumers and investors are setting their own criteria," Ms. Dow said. Regulators also play a part, she said. "Increasingly, financial regulators have accepted that climate risk can pose financial risks."

In March, the Federal Reserve launched a second climate-related committee to address financial stability risks at a "macroprudential" level and to develop a regulatory framework. The Fed is also now part of the Network of Central Banks and Supervisors for Greening the Financial System.

Other U.S. regulators, including the Securities and Exchange Commission and Commodity Futures Trading Commission, now have climate risk initiatives as well.

In 2020, more than $300 billion in green bonds were issued globally, out of a global total of $730 billion for sustainable bonds, according to public sources tracked by Fitch. In the first few months of 2021, there have been roughly $14 billion in green bonds, with 70% issued in Europe.

Exponential growth is expected, Ms. Dow said. "Oversubscription of green bonds is generally very strong," but the need is even greater, with an estimated $1 trillion needed "just to get Europe on track to meet the EU's Green Deal sustainability goals," she said.

"Clients asking for fixed-income allocations focus a lot more on the E (environment)," said Vishal Khanduja, Boston-based director of investment-grade fixed-income portfolio management and trading and portfolio manager of the $841 million Calvert Green Bond Fund. "It is definitely a lot of our conversations with consultants and clients." He sees the growing interest coming from asset owners thinking about how to incorporate ESG into their investment processes, "and then climate became one of the key issues asset owners started to focus on. Green bonds are just a byproduct of that work done by asset owners," said Mr. Khanduja of Calvert, which has $31.8 billion under management.

Helping to increase the assets invested in green bonds is their nearing in size to high-yield offerings, bringing liquidity and diversification, "which is also a big thing for institutional investors," he said.

Asset managers are also helping clients understand the differences between the respective benchmarks for these newer bonds. "Public pension plans have a clear mandate that they're coming with, and one thing they truly want to understand is you are not compromising what an investment should be doing," he said.

"The other thing they are looking for is the true deep proprietary work" behind the green bond offering. "That is one that consultants have honed in," said Mr. Khanduja, who also credits banks that now have dedicated sustainability teams to help consultants and clients understand what they are getting.

"The focus now is trying to report on the impact metrics. We want to go back to clients on how this performed. That's what clients want at the end of the day, and it is a great gut check for us as well to make sure what we intended to happen actually happened in a portfolio," he said.

Investment officials at the $286.9 billion California State Teachers' Retirement System, West Sacramento, believe in green bonds as both an investor and issuer.

CalSTRS has $268 million invested in its green fixed-income portfolio and recently financed a high-profile headquarters expansion project by issuing $340.6 million in green bonds through the California Infrastructure and Economic Development Bank.

The bonds were certified as climate bonds by the Climate Bonds Standard Board, and require a verification report within 24 months of issuance.

The move also earned CalSTRS recognition as the 2020 Green Project Bond of the Year by Environmental Finance. Due for completion in mid-2022, the project incorporates several green building standards and is estimated to reduce CO2 emissions by 56% over a baseline building, and reduce electricity use by 81%. Its green attributes include producing renewable energy, water recycling, a cafe with its own garden and even an "irresistible stairwell" with windows enticing people away from the elevator.

A Climate Bonds Initiative report on green bond pricing in public and private sector bond markets in the second half of 2020 found "increasing signs of greenium," with both European and U.S. green bonds on average performing well on all metrics, including yield curve.