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Bonds are back as higher interest rates offer yields not seen in more than a decade. However, investors are gravitating increasingly toward products that deliver not just better fixed-income performance but better outcomes for the planet.
“We’ve seen a big influx in capital moving into green bonds, and also what we classify as fossil-free and sustainable bonds,” says Mike Thiessen, chief sustainability officer and co-chief investment officer at Genus Capital Management Inc. in Vancouver.
He specializes in responsible investment (RI) strategies and manages three proprietary bond funds for high-net-worth individuals and institutional clients. Mr. Thiessen notes they’re asking for this exposure in their portfolios more than ever.
“A big part is because interest rates have gone up, with people moving from equities into fixed income to find a safe space for their money with a decent yield.”
But that’s not the only reason. Mr. Thiessen says RI-focused fixed-income products are increasingly in demand among Genus clients, and investors in general, because of their concerns about climate change.
An S&P Global report published earlier this year notes that sustainable or green bond issuances are forecasted to reach almost US$1-trillion globally this year, about triple the number of issuances in 2019.
Investor interest remained robust even through last year’s rising rate environment, which hammered bond values. A Morningstar Inc. report noted that sustainable bond fund inflows remained positive while traditional bond funds experienced massive outflows.
The challenge for many advisors and investors is making sense of what’s available among the individual green and social bonds, sustainability-linked bonds, and many mutual funds and exchange-traded funds (ETFs) offering exposure to this small but growing segment of the fixed-income universe.
The choices can be confusing for investors who are new to RI fixed income, says Tim Nash, founder of Good Investing in Toronto. “There is a wide spectrum of bonds and funds to choose from in this space.”
Most advisors and investors look to ETFs and mutual funds, which provide ease of access to the bond market at low cost, says Michael Silicz, portfolio manager with National Bank Financial Wealth Management in Winnipeg. Yet, he says investors still need to understand what’s under the hood because not all funds invest in bonds that support green and social projects directly.
For example, funds such as iShares ESG Aware Canadian Aggregate Bond Index ETF XSAB-T hold bonds of companies with good environmental, social and governance scores, Mr. Silicz says. “But that does not mean these bonds are supporting actual environmental or social initiatives.”
Other funds such as Horizons S&P Green Bond Index ETF HGGB-T offer direct exposure to green bonds that fund specific projects that have positive environmental or climate-related benefits.
Yet, these funds themselves can hold “some curious companies,” Mr. Nash notes. “For example, an ETF may hold energy companies issuing green bonds for energy efficiency or carbon capture.”
That may not satisfy some investors who don’t want to support oil and gas, he adds.
Even individual green bonds present challenges. Mr. Silicz points to a 10-year bond Ontario Power Generation Inc. issued last year.
“This bond raise was ‘for eligible green bond framework projects,’ including maintenance and refurbishment of nuclear energy facilities. Is nuclear green? Some investors would say yes, and others would say no.”
While investors may find themselves compromising on what they consider “green,” they often don’t have to compromise on yields, which are often similar to if not better than traditional fixed income, Mr. Thiessen says.
“Our green bond fund has beaten the benchmark by about 80 basis points over the past two years,” he says about Genus Global Impact Bond Fund, which has a two-and-a-half-year track record and a current 5.17 per cent yield to maturity.
As well, green bonds tend to be less volatile because they’re not traded as much as investors “want to see the completion of projects,” Mr. Thiessen adds.
Other RI fixed-income securities, such as sustainability-linked bonds that are tied to a corporation’s performance toward a broader ESG goal, even include the potential for higher yields.
“Usually, they have a sustainable target like lowering emissions by a set percentage by a certain date, and if they don’t hit that goal, the interest rate on the bonds will increase by a set amount,” Mr. Thiessen says.
For example, Telus Corp. T-T issued a sustainability-linked bond in 2021, which has a condition that if it failed to reduce greenhouse gas emissions by 46 per cent below 2019 levels by 2030, the interest paid to bondholders will increase by 100 basis points.
Sustainability-linked bonds are relatively new. While they may support corporations’ push to reduce emissions, Mr. Nash notes advisors and investors should ask whether the company would’ve been taking those actions anyway.
Unlike sustainability-linked bonds, investors in green and sustainable bonds generally know their capital is supporting clean energy, social housing and low-emission public transport projects. As such, these bonds align more closely with impact investing, in which investors seek to support a tangible, beneficial outcome.
Institutional and high-net-worth investors seek this style of RI increasingly, Mr. Thiessen says. “First, they wanted all their equities to be high impact, and now they want all their fixed income to be high impact too.”
Impact investing can lead to a narrower portfolio, but these investors understand they’re forgoing some diversification to address other risks such as climate change and economic inequality, Mr. Nash says. “They really do fund change for the better.”
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