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Green bonds: Sustainable finance opportunities in public fixed income

August 23, 2019 — In this Q&A, the Eaton Vance floating-rate loan team offers its perspective on today’s loan market.

By: Craig P. Russ; Andrew Sveen, CFA; Ralph Hinckley, CFA; Christopher Remington

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By Vishal Khanduja, CFACalvert Fixed Income Portfolio Manager and Brian S. Ellis, CFACalvert Fixed Income Portfolio Manager

Boston - With interest in responsible investing well established on the equity side, investors appear to be increasingly applying a responsible lens to fixed-income strategies.

This interest is driven primarily by two shifts. First, investors increasingly believe, as we long have, that the consideration of financially material ESG (environmental, social, and governance) factors can enhance risk-adjusted performance over the long run. Second, interest in impact investing in public markets has been growing rapidly. With the ability to direct capital to specific projects, fixed-income investments offer inherent advantages in this market.

Within impact investing, a particularly fast-growing area is green bonds. For instance, we saw global issuance of green bonds rise to $167.6 billion in 2018, nearly twice as much as was issued in 2016, according to Climate Bonds Initiative (CBI). This growth is also coming from a wider range of sectors. For example, over the past two years ended 2018, we've seen increased participation from securitized assets, sovereigns and financial corporates, according to CBI data.

Calvert has been researching and investing in green bonds for years, and we have seen demand and issuance grow from both the supply and demand side. On the supply side, countries must make large investments in projects to meet their commitments to the Paris Agreement, which aims to limit the rise in global temperatures to 2 degrees Celsius above pre-industrial levels. Corporations are increasingly recognizing the economic benefits from energy and resource-efficiency investments.

On the demand side, ESG-focused investors are increasingly pursuing impact investment opportunities, and climate change issues remain at the forefront.

What is a green bond?

Despite this rapid growth, green bonds are still a relatively new and less understood asset class. For example, there is a lack of a standardized definition on exactly what qualifies as a green bond. As the market has evolved, several opinions have emerged.

Today, a bond carries a green "label" if it adheres to the International Capital Market Association (ICMA) Green Bond Principles, and an independent opinion provider certifies conformance to the principles at issuance. Labeling efforts have driven the transparency and accountability needed for continued growth, but have not resulted in a unified view on the key question facing impact investors: What exactly is a "green" bond?

A proprietary, comprehensive approach

At Calvert, environmental issues have long been an important focus of our research and advocacy efforts. This work formed the basis of our proprietary green bond criteria.

While we value the work of standards and opinion providers, and often consult them in our analysis, our research process focuses not only on the underlying projects, but also broadly on the issuers themselves. As a result, we do not rely exclusively on independent certifications, just as we would not solely rely on a fundamental credit ratings report.

Calvert looks beyond the label

Green bonds typically contain use-of-proceeds language that earmarks funds for green projects. However, most are unsecured obligations that are equal to the issuer's other outstanding debt.

This makes credit and ESG analysis of the issuer critical, and this closer look often answers key questions important to our green criteria.

These are some of the questions we ask regarding the issuer:

  • Are the green projects consistent with the issuer's overall sustainability goals and performance?
  • Is the issuer financing operations or products with environmental risks that more than offset the project benefits?
  • If the issuer operates in a resource-intensive industry, is there sufficient evidence the project will materially improve the issuer's net environmental performance and/or realize opportunities to shift its sustainability goals?
  • Moreover, does the issuer perform strongly on environmental issues overall, but poorly on social and governance issues?

We may decide an issuer is not appropriate for investment if we are not comfortable with its credit risk, overall performance on material ESG issues or valuation.

Through this lens, investment opportunities can be found in non-labeled securities that we believe are equal to or better than those solely offered in the labeled green bond market. In Calvert's criteria, these fit into three categories:

1. Green projects with clear use-of-proceeds language (i.e., asset-backed securities backed by renewable energy and energy efficiency loans).

2. Solutions providers: Issuers that derive most of their revenues from clean technology or environmentally beneficial products or services.

3. Leaders: Issuers that demonstrate leadership in material environmental issues and, thereby, elevate industry norms.

Bottom line: We expect the strong underlying trends driving interest in green bonds to continue. We believe investors pursuing an active investment approach from a fundamental and impact standpoint are likely to benefit from increased opportunities and more diversified portfolios. We also believe a disciplined approach with experienced fundamental credit and ESG research teams is critical to success in the sector.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.