Socially responsible investments have become an increasingly popular theme in the equities space, and fixed-income investors may also have the opportunity to retrofit their portfolios with a green bond exchange traded fund to potentially enhance overall returns while maintaining a socially responsible mindset.
“Managing exposure to ESG factors is a growth opportunity for fixed income asset managers, displays potential for outperformance globally, and is a value-added risk management technique on an ex-post and ex-ante basis,” writes Pat Reilly, V.P, Sales manager, Fixed Income, FI Analytics, said in a FactSet research note, referring to environmental, social and governance factors.
Green funds remain a popular play, especially over the past decade as rising concerns over climate change helped fuel the investment theme. The investments typically draw younger and more environmentally minded investors who see profits in the nascent green industry.
Reilly argued that the idea that environmental and social pillars are morality plays for fixed-income investors as they are the right thing to do, whereas the governance pillar is seen as instrumental in maintaining capital preservation.
By incorporating ESG principles, bond investors are exposed to many credit analysis processes that go beyond traditional market cap-weighted methodologies.
Green bonds also often feature lower correlations to other fixed income assets, a possible advantage for income investors at a time of diverging monetary policies throughout much of the developed world.
For instance, the VanEck Vectors Green Bond ETF (NYSEArca:GRNB), the only bond dedicated to the socially responsible investment theme, only includes debt issuer that indicate the bond’s “green” label and the rationale behind it, such as the intended use of proceeds. As an additional filter, the bond must be designated “green” by Climate Bonds Initiative, an international not-for profit working to mobilize the bond market for climate change solutions.
Related: Green Bond ETF Won’t be Hurt by Trump’s Paris Decision
Green bonds include debt securities whose proceeds are used principally for climate change mitigation, climate adaptation or other environmentally beneficial projects, such as, but not limited to, the development of clean, sustainable or renewable energy sources, commercial and industrial energy efficiency, or conservation of natural resources.
Investors can evaluate the green bond segment’s impact through the standardized Green Bond Principles. Specifically, the principles include use of proceeds, which should fund projects with clear environmental benefits with clear disclosures; project evaluation and selection, which outlines a process to determine project eligibility and sustainability objectives; management of proceeds, which should be tracked through a formal internal process; and reporting, or annual disclosure of the use of proceeds and qualitative and quantitative performance measures.