Green bonds climb as investors try to match their environmental goals

In a relatively short eight years, green bonds have come from out of the blue to give fixed-income investors a feel-good alternative. Environmentally correct bonds have emerged as a legitimate force in fixed income, with issuance hitting $36.6 billion last year, more than six times the $6 billion issued in 2012. Though that's still a small number in the context of a global bond market that tops $100 trillion, green bond issuance in 2014 was more than double the $15 billion issued in 2013. “Green bonds represent the fastest-growing sector within the socially responsible investing space,” said Louise Herrle, managing director of capital markets at Incapital. Green bonds are debt issued to raise money for environmentally friendly projects and causes. “The growth can be attributed to a couple of things,” Ms. Herrle said. “There has been an explosion of investor interest, and the sector has matured.”

SET OF PRINCIPLES

That maturity can, in large part, be pegged to the International Capital Market Association's adoption last year of a set of green bond principles to which the fixed-income industry has generally adhered. Even though the principles are “completely voluntary,” Ms. Herrle said, they are designed to provide basic guidelines and to help prevent instances of issuers “green-washing” their debt to attract environmentally conscious investors. “It's a way for the issuer to communicate about the use of the proceeds of the debt they're issuing, because it's not about the issuer, it's about the proceeds,” Ms. Herrle said. A unique aspect of the green bond market is that a corporation doesn't have to be christened green to issue green bonds, as long as the proceeds from those bonds are used for qualifying green projects. Eligible projects include renewable energy, clean transportation, sustainable waste management and energy efficiency. As the category has gained some heft, the debate has heated up concerning what qualifies as green in the fixed-income universe. But most proponents of green bonds view the increased scrutiny as a positive development. Benjamin Bailey, co-manager of the Praxis Intermediate Income Fund (MIIIX), described his fixed-income strategy as “green inclined” and acknowledged that despite the market's growth, it would be difficult today to build a fully diversified strategy using just green bonds. “We're probably years away from that point, because the corporate sector has been slow to grow in terms of green bonds,” he said. The pace was set early on by such environmental and social justice leaders as The World Bank and the European Bank for Reconstruction and Development. “There has been a lot of growth in the supranational, sovereign and foreign agency space,” Mr. Bailey said. “You could get a very diversified portfolio if all you cared about were those areas of fixed income.” J. Brent Burns, president of Asset Dedication, which builds customized bond portfolios, recognized the potential of green bonds as a marketing strategy, which makes the case for more issuing companies' jumping on the bandwagon. “A lot of folks want to put their money where their heart is,” Mr. Burns said. “If a pension fund, or a particular investor, has a mandate or a heart that drives them to something like that, it's a good thing.” He said he doesn't seek out green bonds for investment but added, “I like the concept.”

LINGERING QUESTION

While equity strategists and fund managers have been applying various investing screens related to religious, environmental and social issues for decades, stock funds have never quite resolved the question of whether investors are sacrificing performance in support of a cause. As Mr. Burns pointed out, though, that's less of an issue with bonds, because they present investors with the yield at the time of purchase. That makes them much easier to compare with nongreen bonds. “On the equity side, I think investors have always feared the "give-up factor,'” he said. “But with a green bond, it's clear the day that you buy it what you're going to get, because it's a bond.” There is no indication of a significant performance difference between green and nongreen bonds, according to Delmar King, who co-manages the Praxis bond fund with Mr. Bailey. “Green bonds are generally in line with other comparable credits,” Mr. King said. But Ms. Herrle said establishing the return differential will be more difficult in fixed income than in equities because of the nature of the bond markets. “Some issuers will believe they're taking the trouble and added expense of the segregation of the funds, plus offering a social return in addition to the investment return, so they may shave off a couple basis points, but others will issue the debt at the same level as other debt,” she said. On the investor side, Ms. Herrle said, “certain funds might be willing to give up a couple of basis points to get a green bond, but most investors have a threshold for how much yield they will give up to support certain activity.”