Environmental, social and governance (ESG) investments have a data problem. It's not that the data underpinning these investments is bad—far from it. The problem is that there's too much of a good thing, and nobody can agree on which data points should take precedence over the rest.
As more and more ETF issuers launch their own ESG products, it's gotten harder for investors to sort the real impact investments from those that make an impact in name only.
Enter green bonds. This special category of debt allocates dollars toward specific eco-friendly projects, making it one of the most concrete ways for investors to make an impact with their money.
We take a closer look at green bonds and the two ETFs tracking this space below.
ESG: Expectation Vs. Reality
Most ESG indexes are designated as such because they use environmental, social and governance data to select, rank and/or weight securities, a method designed to weed out the worst actors and prioritize top performers.
The problem is, company rankings can and do vary widely among data providers, as there is no standardized definition of what "ESG" means, or which lever—environmental, social or governance—should take priority in any given index.
As a result, wide disconnects can arise between what ranking data counts as an 'ESG' company and what investors expect. For example, an oil company may score well on corporate governance and social issues, such as workplace gender equality, but most ESG-minded investors would probably still expect the oil company to be excluded from an ESG index.
Our example isn't just hypothetical: Exxon Mobil (XOM) appears in several socially responsible ETFs, including the $140 million Goldman Sachs JUST U.S. Large Cap Equity ETF (JUST), the $103 million Xtrackers S&P 500 ESG ETF (SNPE), the $57 million FlexShares STOXX U.S. ESG Impact Index Fund (ESG), and more.
Definitions become even trickier in the fixed income space. When evaluating corporate and sovereign debt, should governance principles take higher priority than environmental stewardship or dedication to social causes? What types of debt could be considered ESG? And how does one even decide the ESG principles of a bond issue, anyway?
Green Bonds For Eco-Friendly Projects
Green bonds circumvent these headaches entirely. "Green bonds" aren't "green" because they're debt issued by companies with exceptionally high ESG scores. Rather, they're "green" because they finance specific environmentally friendly projects, such as habitat restoration efforts, energy efficient buildings, zero-emission public transport, or solar farms.
As such, green bonds are ideal for investors who want to make a concrete impact—specifically, to aid in the efforts to mitigate climate change. Rather than buying stock of highly ranked companies and hoping the c-suite will use the cash wisely, green bonds allow investors to directly fund projects they believe will make the world a better place. (Read: "Why Impact Investing's Time Has Come.")
Issuance of green bonds is on the rise, according to data from VanEck, which runs one of the two green bond ETFs on the marketplace. Last year, roughly $171 billion in green bonds were issued; this year, that figure is projected to reach $250 billion.
Two Green Bond Funds
Currently there are two green bond ETFs on the market: the $26 million VanEck Vectors Green Bond ETF (GRNB) and the $35 million iShares Global Green Bond ETF (BGRN). GRNB has been around since 2017, while BGRN launched late last year.
Both ETFs track a basket of green bonds, but how that designation is assigned differs between the funds. GRNB is the 'purer' take on green bonds, using debt classifications from the Climate Bonds Initiative, a London-based non-profit whose sole purpose is to identify and certify climate-change mitigating debt. (Read: "Top 5 Standout Launches Of 2017.")
BGRN, meanwhile, relies on MSCI criteria to select eligible securities for its index. Bonds do not need to be explicitly labeled as "green bonds," so long as they meet MSCI's four green bond principles regarding the use of their proceeds and transparency in reporting.
That's likely the reason why BGRN's portfolio is nearly twice as large as GRNB's, and why its liquidity is significantly higher. Though neither fund trades particularly frequently, BGRN's average spread is 0.17%, while GRNB's is 0.22%.
Performance Vs. Yield
(For a larger view, click on the image above)
Source: Koyfin.com; data as of 11/8/2019
The different in portfolio make-up has also had a significant impact on performance. Over 2019, BGRN has handily outperformed its purer-play rival; year-to-date, BGRN is up 9.7% compared to GRNB's 4.6%.
However, GRNB offers the higher yield, which for fixed income investments is just as important a metric. According to issuer websites, GRNB's 30-Day SEC Yield is 2.54%, while BGRN's is 0.70%. (30-Day SEC Yield is the interest an investor in the fund would have earned in the past 30 days, after expenses are deducted.)
Both funds have an expense ratio of 0.20%.
Contact Lara Crigger at [email protected].