Sage: When The Soup Is ‘Green’

November 28, 2018

[This ETF Industry Perspective is sponsored by Sage Advisory]

Within the world of sustainable investing, the soup du jour comes in the form of green bonds. Most of the time, the soup (bond) of the day is a fresh, tasty offering that satisfies the diner’s appetite and fits within the flavors of their overall meal (portfolio). Sometimes though, the soup (bond) fails to live up to its billing (label) and can create discordance with the rest of the meal (portfolio). It’s important for investors to know that the labeling of green bonds can vary, and there are three different categories in regard to the certification of their labeling.

Note: Over the first half of 2017 there was approximately $71 billion in green bonds issued globally, and $146 billion issued overall in 2017. Through the first half of 2018 there has been $63 billion issued, which will put overall 2018 issuance short of the forecasted $250 billion in green bonds.

10% of the current market is aligned with the Climate Bond Principles (CBP) and is certified by the Climate Bonds Initiative (CBI).

73% of the current market is aligned with the CBP but lacks official certification. A large percentage of these aligned green bonds have ratings and/or certifications (from firms such as Sustainalytics) regarding their use of proceeds and ongoing reporting.

17% of the green bond market is “self-labeled” and not aligned with the CBP. It is this last group of bonds that should give investors pause about the issuance’s current and ongoing use of proceeds as it pertains to green projects. Self-labeled green bonds require a deeper dive into the use of proceeds.

Considerations For Green Bond Investors
Within the domestic fixed-income market, there are certain constraints and issues that can cause problems for investors seeking to add green-labeled debt to their portfolios. From a portfolio construction perspective, there are a few issues.

First, the U.S. federal housing mortgage agency Fannie Mae is the largest domestic issuer of green bonds. These bonds are focused on supporting energy-efficiency projects across its multifamily residential housing lending portfolio. Multifamily mortgage-backed security (MBS) green bonds issued by Fannie Mae are smaller in issuance size, at around $300 million (within the context of the entire MBS universe size, where major Fannie Mae single-family pools average around $1 billion); contain lower-quality collateral; and are typically targeted by banks that have long-term holding periods. These factors lead them to have reduced liquidity, making them more attractive to low-turnover mutual funds and less so for actively traded separately managed accounts.

Second, the corporate green bond issuance is limited in both size and in the number of unique issuers. From a portfolio construction standpoint, these factors can lead to a green bond portfolio with decreased liquidity, a higher-than-desired concentration in a single issuer and a lower-than-desired asset class diversification.

Muni & Global Green Bonds
For municipal green bonds, there are similar issues regarding liquidity and long-dated issues. There is also a lot of self “green” labeling that takes place within the municipal market. The required documentation needed to label a municipal offering “green” on its offering statement is minimal, and once labeled, there is no ongoing assurance that the proceeds are being used as intended. This can lead to formerly “green” bonds, where the use of proceeds may have shifted to nongreen projects.

For the global fixed-income green bond market, the dimensions and characteristics are somewhat different. Europe remains the largest issuing region of green bonds, driven by large issues from European sovereigns and financials. This can lead to an outsized regional concentration, along with a large concentration within the sovereign and financial sectors.

Another issue has been the increased issuance of green bonds originated in China and their differing standards as to what constitutes a green bond. Recently, the CBI has decided to exclude Chinese bonds that are labeled “green” since they are being used to fund clean coal projects and working capital of utilities with clean coal assets. These types of projects do not align with the CBP, which, much like self-labeled municipal debt, can lead to investors holding bonds that are not as green as they thought.

Sage is an advocate of sustainable investing. We are also advocates of responsible investments within the green bond market. We believe that the best way to access the green bond market is to choose certified green bonds where the use of proceeds are continuously verified to align with a globally accepted framework of green bond guidelines. By creating consistency as to what constitutes a green bond, investors will be able to put more faith in the label and in the true “green” alpha that the bond is going to add to their sustainable value set. For any other bond labeled “green” that hasn’t been certified, we feel that an in-depth look into the use of proceeds is needed, along with ongoing self-monitoring of investments.


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