Green Bond-anza: Making Sense of the Categories

Wind turbine image courtesy of Praxis Mutual Funds

INTRODUCTION

With the recent announcement that the European Union will begin issuing green bonds starting in October of 2021 and predictions that have annual green bond issuance hitting $1 trillion by 2023, many have been left wondering: “What exactly is a green bond?”

Green bonds allow investors to buy bonds that make a specific impact on the environment, often with specific attention to climate. Green bonds first came to the U.S. market in 2009 with an International Bank for Reconstruction and Development (IBRD) issuance. The green bond market started slowly, but a slow and steady start has led to the strong and diverse market of today. Successes in the green bond space later led to the introduction of social and sustainability bonds. Recently, the issuance of positive impact bonds has grown to include new categories, such as blue bonds and sustainability-linked bonds.

For many investors and clients, it can be exciting to learn that by actively lending to issuers who are making a positive impact, they are able to support a variety of life-altering causes such as bettering the Earth’s air quality, educating children, providing affordable housing and more.

Traditionally, investors who wanted to make an impact were more likely to “screen out” bonds that had negative societal impacts. However, investing in positive impact bonds allows investors to make a greater, more diverse and more intentional impact.

Current Trends in the Green Bonds Space

Scathing climate reports like IPCC climate report released in August 2021 and growing concern about climate change has led to accelerated growth in the green bonds space. The green bond market continues to grow at an exponential pace, with cumulative green bond issuance surpassing $1.2 trillion in 2021. Additionally, when thinking about the breadth of the green bond market, it is important to note that there has consistently been strong issuance in different maturity buckets and across different rating categories.

In the U.S., the social and sustainability bond issuance has been lower than that of green bonds, but these markets have grown substantially in recent years, with a huge increase in 2020. The COVID-19 pandemic and racial justice movements are partially what spurred growth in social bond issuance starting in 2020. For example, this commitment to racial justice can be seen in the financial corporate bonds that went to supporting black-owned banks. Similarly, the COVID-19 pandemic catalyzed the sustainability bond issuance in 2020 with several large companies like Alphabet and Sysco issuing sustainability bonds.

This is not just a phenomenon in the U.S., as globally, too, green bonds are on a tear. According to Bloomberg, the issuance of positive impact bonds continues to rise globally; already in 2021, over $794 billion in green, social and sustainability bonds have been issued versus just under $500 billion in all 2020. Issuance continues to increase each year, with YTD 2021 already having 2,095 different positive impact bonds issued versus only 1,362 issued in 2020.

Comparing Green Bonds and Other Impact Bond Categories

What Does the Future Hold?

We continue to see high growth in the social, green and sustainability bonds market, and due to the increasing concern about the environment and mitigating climate change, we anticipate a continued appetite for green bonds.

As the positive impact bond market continues to grow, some investors might have heard the term sustainability-linked bonds (SLB), and they might wonder what role SLBs could play moving forward. Sustainability-linked bonds don’t necessarily use the proceeds for green projects; instead, the coupon of the bond can vary based on whether or not the issuer meets predefined green or social objectives within a predefined timeline. This penalty in higher borrowing costs should motivate the issuer to meet the set targets.

The SLB market is still relatively young and while some issuers have strong environmental, social and governance (ESG) integration and a more progressive business model, other companies may be further behind on their ESG journey. While some investors may prioritize buying bonds from companies that already have high ESG ratings, sustainability-linked bonds that are issued by companies with historically low levels of ESG integration should not be discounted solely due to their poor sustainability performance in the past.

Moving forward, sustainability-linked bonds could be seen as a tool that impact investors can use to incentivize companies that have struggled to address ESG concerns to become more sustainable, increase diversity or implement other green or social initiatives. Our criteria in analyzing SLBs is to make sure that real impact is being delivered, that the stated objectives are not too easily achieved and that the coupon increase is meaningful.

At Praxis Mutual Funds®, we know that there is more than one way that investors can directly impact the world. Strategically buying positive impact bonds is one approach that can drive improvements within issuers. Additionally, we stress the importance of investor engagement as an important tool in encouraging companies to embrace better governance and increased sustainability.

Although shareholder engagement is better known, bondholders can also make an impact by reaching out to issuers and underwriters about important ESG topics—especially when it comes to companies who are more likely to favor traditional solutions. Bondholder engagement allows investors to effectively convey to companies how these issues are important to them and the company’s future.

As positive impact bonds continue to rise in issuance and popularity with investors, it is important to see how these bonds open another avenue for savvy impact investors to make a real difference with their portfolios. By understanding the distinctions between green, social, sustainability and sustainability-linked bonds, investors can and should make intentional choices about how they want their bond purchases to impact the world—be it through underwriting the addition of solar to a utility company, encouraging a company to increase diversity in the board room, supporting affordable housing construction or any number of projects that positive impact bonds back worldwide. Our changing climate demands major structural changes in many areas, and people should realize that their investments can make a difference, too. Green bonds and positive impact bonds are a great way to get started by investing together, impacting the world.

 

Article by Benjamin Bailey, CFA®, Vice President of Investments, Praxis Mutual Funds.

Benjamin joined Everence in 2000 and was named Co-Portfolio Manager of the Praxis Impact Bond Fund in March 2005, and Co-Manager of the Praxis Genesis Portfolios in June 2013. In 2015, he was named Senior Fixed Income Investment Manager, providing leadership to the fixed income team and oversight to external sub-advisory relationships. Benjamin is a 2000 graduate of Huntington College in business-economics. Connect with Benjamin on LinkedIn.

Disclosures and Additional Information

Consider the fund’s investment objectives, risks, charges and expenses carefully before you invest. The fund’s prospectus and summary prospectus contain this and other information. Call 800-977-2947 or visit praxismutualfunds.com for a prospectus, which you should read carefully before you invest.

Praxis Mutual Funds are advised by Everence Capital Management and distributed through Foreside Financial Services, LLC, member FINRA. Investment products offered are not FDIC insured, may lose value, and have no bank guarantee.

As of Aug. 31, 2021, the Praxis Impact Bond Fund has invested 0.17% of its assets in Enel, 0.39% of its assets in IBRD, 0.32% of its assets in IFC and 0.14% of its assets in Starbucks; the Praxis Growth Index Fund has invested 7.09% of its assets in Alphabet Inc. and 0.34% of its assets in Starbucks; the Praxis Value Index Fund has invested 0.38% of its assets in Starbucks and 0.26% of its assets in Sysco; the International Index Fund has invested 0.36% of its assets in Enel. Fund holdings are subject to change. To obtain holdings as of the most previous quarter, visit praxismutualfunds.com.

Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates. The Fund’s investment strategy could cause the fund to sell or avoid securities that may subsequently perform well, and the application of ESG screens may cause the fund to lag the performance of its index.