Green Bonds as Part of an ESG Investing Strategy

Reports of environmental, social and governance (ESG) investing and new products tend to focus on the equity side of investing, but an Insights report from Lazard Asset Management argues there is value in investing in green bonds.

Yvette Klevan, managing director and portfolio manager/analyst at Lazard explains in her report that a green bond is a standard fixed income instrument whose proceeds are used to finance “green” or environmentally friendly projects. “This type of investment is compatible with an ESG framework (especially the environmental and social factors). In the past, investors have tended to focus more specifically on governance factors to better understand the risks and opportunities associated with lending to different entities. Today, however, instruments like green bonds are allowing investors to directly address the environmental and social aspects of their investments. Proceeds from green bonds issued to finance solar or wind projects, for instance, may also provide clean water, lessen pollution, and introduce a sustainable energy source to remote areas,” she says.

Klevan adds that green bonds are particularly important to the clean energy, infrastructure, and transportation industries as they allow countries and companies to obtain funding to achieve positive and sustainable environmental and social goals. “Ultimately, we believe that an active and tactical approach to investing in green bonds may allow investors to better manage risk factors, such as those relating to currencies and rates,” she says.

According to the report, demand for green bonds is surging. Green bond issuance has steadily increased since 2007 and is expected to surpass $250 billion in 2018.

Green bond principles and investment opportunities

Rules continue to emerge to govern the nascent green bond sector, according to Klevan, who notes that the Green Bond Principles (GBP) are currently the most well-established framework for evaluating these instruments. The GBP were developed by the International Capital Markets Association and have four components: use of proceeds, process for project evaluation, management of proceeds, and project reporting. These are voluntary guidelines and the determination of what constitutes a green bond is still left to the issuers and underwriters.

Moody’s constructed a methodology to assess the environmental credentials of issuers. Its framework evaluates the issuer’s approach to managing, administering, allocating, and reporting on the projects financed by green bonds, and produces a composite grade ranging from “Excellent” (GB1) to “Poor” (GB5). The use of proceeds carries the largest weighting (40%) in their score. S&P also launched a Green Evaluation Tool to score green projects according to the quality of governance, transparency of a transaction, and the environmental impact associated with the project.

As for choosing green bond investments, Klevan says the Bloomberg Barclays MSCI Global Green Bond Index draws heavily from the GBP and has a stated aim to offer investors an objective, robust measure of the green bond market.

“As society focuses on reducing its carbon footprint, we believe portfolios that recognize this secular trend and proactively reduce their carbon exposure may be better positioned to outperform the broad market. We believe an investment approach that emphasizes sustainability is better placed to add value in the long run. Based on our observations as managers of global fixed income portfolios, the integration of ESG factors and green bonds into the investment process can help investors reap opportunistic gains as well as defend returns,” Klevan concludes.