Green bond market just getting started

The $50 trillion global bond market might be more than three times the size of the global equity market, but when it comes to adopting environmental, social and governance strategies, the fixed-income market is just getting started.

A lack of uniform definitions and reporting standards makes it difficult to calculate precisely the size of the market, but analysts’ estimates peg the green bond market at roughly $136 billion. And it’s growing rapidly.

“We were watching the green bond space for many years and the market was just too small to launch a green bond ETF, then three years ago we noticed the issuance of green bonds started doubling every year,” said William Sokol, director of ETF product management at VanEck, which launched the VanEck Vectors Green Bond ETF (GRNB) in October 2017.

The ETF is still small at just $27 million, but a move in September that cut the expense ratio and shifted the fund to a​ U.S. dollar-denominated index represents progress and potential.

Morningstar’s data show 800 fixed-income funds managing a total of $375 billion with at least the potential to invest in green bonds.

Europe more active

With the majority of the global green bond market fueled by European demand and issuance, 65% of the investible universe is denominated in the euro. That fact doesn’t prohibit U.S. investors from participating, but it does introduce currency risks.

While it’s still relatively small, the growth of the green bond market represents a new channel for ESG-conscious investors and financial advisers, and if the ESG influence sees the same kind of growth and expansion in bonds as it has in equities, the fixed-income market is on track to be permanently altered.

Michael Temple, portfolio manager and director of credit research at Amundi Pioneer, said green bonds could eventually pay lower yields because they could be viewed as “riskless in one category.”

For corporations and municipalities issuing bonds, that could mean lower borrowing costs, which directly impacts the bottom line, thus driving more corporations to adopt green policies.

“Currently, green bonds are largely a carve-out by most corporations,” Mr. Temple said. The growing demand will give these green bonds preferential treatment in the marketplace, and the corporations get to hold themselves out as being greener.

One problem with green bond issuance, Mr. Temple said, is that money is fungible and, as with municipal-bond revenues, it can be difficult to track how the green bond money is being spent.

Another current problem with green bonds is the lack of standardization and strict definitions for green bonds.

“When it comes to ESG metrics, there typically isn’t a standard or there are many standards,” Mr. Temple said. “Anytime you don’t have clear, agreed-upon guidelines as to what defines a specific type of financial instrument, people and organization could try to take advantage.”

But even as he sees the shortcomings, Mr. Temple said the challenges can and will be rectified because the benefits of green bonds are just too great to stop them from becoming a larger part of global debt issuance.

Under construction

At the fund level, where most financial advisers gain access to bonds for their clients, the green bond infrastructure could best be described as under construction.

Karin Anderson, director of manager research at Morningstar, divides green bond funds into three broad categories: the consideration group that includes ESG integration in the prospectus, the focus group that includes funds integrating ESG criteria throughout the investment process, and the impact group of funds that makes ESG a priority.

In the consideration group, Ms. Anderson cites BlackRock, T. Rowe Price and Wellington as examples of asset managers that have recently added dedicated ESG teams and introduced new language to prospectuses that supports ESG strategies.

Focus group examples include Amundi, Nuveen, Pimco and Robeco, all of which are integrating ESG criteria throughout the investment process, Ms. Anderson said.

The impact group identifies specific funds at firms including Domini and Calvert, where ESG investing is “front and center,” she said.

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The impact group combines for approximately $37 billion in total assets, or about 10% of the $375 billion managed by all three categories combined.

“The green bond market is so small, even green bond funds are probably not 100% investing in green bonds,” Ms. Anderson said. “This is still a small market and not everyone wants a dedicated fund.”

Related Topics: Socially Responsible Investing