SWISS - Why passive for green bonds?
Francois Millet, Head of ESG, Innovation & Strategy
5 reasons to go passive for Green Bonds
A lean, clean and green approach
**FOR QUALIFIED INVESTORS ONLY– This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).**
"Our house is on fire"
Sebastian Mang, Greenpeace EU climate policy adviser
Head of ESG, Innovation & Strategy
Despite a record-breaking year of inflows into ESG ETFs in 2019 – and a record year for new green bond issuance – the trend towards sustainable investing is only likely to accelerate. In this article, François Millet, Head of Strategy, ESG & Innovation, gives five reasons why investors should consider taking a passive route to green bond investing.
The ongoing climate emergency wreaked havoc in 2019. Cyclone Idai claimed thousands of lives across south-eastern Africa. France recorded its highest ever temperature of 45.9°C, while Venice saw its streets and squares ravaged by floods.1
Meanwhile, the devastating bush fires in Australia rage on, with 70-metre-high flames reported (that’s higher than the Sydney Opera House). So far, the fires have claimed 14.8 million acres of bush, forest and parks.2 To put that into perspective, that’s twice the surface area of Belgium.
While some may have simply been unfortunate “Acts of God”, the growing frequency and intensity of such events may well be the by-product of climate change.
It’s a sobering picture, but we’re encouraged by the real shift in mindset we saw in 2019. Extinction Rebellion protests, Beyond Meat’s IPO, the so-called ‘Greta effect’ – momentum is building and, as last year’s inflows suggest, investors have shown they care too.
This is great news, because finance has the power to change the world. Green bonds in particular could help fuel the transition to a low-carbon future, given their proceeds are earmarked solely for the financing of eco-friendly projects and assets.
At Lyxor, we believe the best way of investing in green bonds is to choose a passive fund. Read on to find out why.
"France recorded its highest ever temperature of 45.9°C in 2019."
1The Guardian, 19 Dec 2019: https://www.theguardian.com/commentisfree/2019/dec/20/2019-has-been-a-year-of-climate-disaster-yet-still-our-leaders-procrastinate
2BBC News, 3 Jan 2020: https://www.bbc.com/news/world-australia-50951043
1. Setting standards
Green bonds are on the right pathway to standardisation
What is the Climate Bonds Initiative?
The CBI is an investor focused, not-for-profit organisation dedicated to promoting investments for a low-carbon and climate-resilient economy. As part of its remit, the CBI issues certification and accreditations to green bonds. To be approved, bonds must comply with the Climate Bonds Standard, a framework fully aligned with the Green Bonds Principles, although it goes a bit further. It specifies a detailed taxonomy of eligible projects and assets, plus rigorous pre- and post-issuance requirements.
A common challenge for ESG (Environmental, Social and Governance) investors is wrapping their heads around the lack of standardisation. While frameworks do exist, reaching consensus on what makes a company “good” or “bad” is easier said than done. This often boils down to personal values, priorities and preferences.
But in the world of green bonds, definitions of what makes a bond truly ‘green’ are much easier to come by. The green bond market is arguably the most standardised area of ESG investing, especially compared to ratings-based ESG funds, or thematic funds with heterogeneous criteria.
Green bonds are issued with reference to an issuance framework, generally the Green Bond Principles (GBPs) of the International Capital Market Association (ICMA). Some may use other frameworks, but these are generally issued by supranationals or sovereigns following guidelines close to those of the GBPs anyway. Most of these self-labelled green bonds then receive second-party opinions by qualified agencies and auditors. The Climate Bonds Initiative (CBI), an investor-focused not-for-profit organisation dedicated to the mobilisation of fixed income markets for climate change solutions, can also certify green bonds.
What matters the most when you invest in green bonds?
- The types of issuers I'm funding
- Not sacrificing performance
- Keeping costs low
- Knowing the bonds truly are 'green'
- Not sure - I need more education
While the ICMA largely comprises issuers, banks, securities dealers and brokers with a largely issuer-focused perspective, the CBI offers more to investors. Not only is it fully aligned with the GBPs, it also goes a step further by assessing issuers based on their use of proceeds, reporting standards and adherence to a strict taxonomy. In fact, the CEO of the CBI is one of the members of the European Commission’s Technical Expert Group (TEG) on sustainable finance. The CBI’s taxonomy is thus taken very seriously.
2. Building consensus
Ongoing dialogues with relevant stakeholders
The CBI’s role in defining a robust taxonomy and standards for green bonds is based on feedback from working groups comprising investors, scientists, supranationals, NGOs and banks. As a result of these ongoing dialogues, the CBI helps keep the market informed and ensures it evolves along a healthy pathway to a greener world.
Source: Climate Bonds Initiative
In fact, in December 2019, the CBI launched its third version of the international Climate Bonds Standard which is designed to ensure compatibility with the new EU Green Bond Standard (GBS) and the latest version of the Green Bond Principles (GBPs) by strengthening green definitions and disclosure requirements.
The findings of the CBI contain valuable insight for green bond issuers. For example, in a recent survey conducted by the CBI and co-sponsored by Lyxor, European investors expressed a high interest in corporate issuers from the Energy, Utilities and Industrials sectors. Like it or not, major emitters and polluters from these sectors have a critical role to play in achieving the European Climate Foundation’s target of net zero greenhouse gas emissions by 2050. Urgently engaging with these companies to consider more green bond issuances will be critical. Shunning them isn’t the answer, but investing in their bonds could be.
Chart source: Climate Bonds Initiative, Green Bond European Investor Survey 2019
So whatever the nature of the issuer, investors can invest in their green bonds with a clear conscience, knowing that their proceeds will only be used to fund pro-climate projects and assets. The CBI’s consensus-backed standardisation and its strict taxonomy help pave the way for passive investments, and address the risk of ‘greenwashing’, where investments are made to seem more climate-friendly than they are. At Lyxor, only green bonds approved by the CBI are eligible for inclusion in the underlying indices of our green bond ETF range.
3. Increasing transparency
See how your money is making an impact
All investors want transparency around where their money is going, even more so when it comes to sensitive ESG investments such as green bonds. As with all passive ETFs, fund holdings are disclosed daily and are readily available – you can easily find them online on Lyxor’s product pages.
Furthermore, holders of our green bond ETFs can see the use-of-proceeds in action. The chart below shows the UoP (Use-of-Proceeds) category breakdown of the Solactive Green Bond EUR USD IG index underlying our ETF launched in 2017.3
Use-of-Proceeds breakdown - Solactive Green Bond EUR USD IG index3
But we don’t stop there. Knowing which kind of categories your money is financing is useful, but not enough to truly quantify the impact of your investment. That’s why we provide monthly reports on our website with detailed information on our funds’ climate and ESG metrics.
We also provide more tangible figures, such as new installed renewable energy generation capacity (in MWh) and emissions avoided (in tons of CO2). In more relatable terms, we estimate that the impact of our first green bond ETF over a one-year period equates to the average energy use of over 5,000 homes, or the equivalent in avoided emissions of close to 12,000 passenger vehicles driven for a year.4
Estimated impact of the Lyxor Green Bond (DR) UCITS ETF over a 1 year period4
3Lyxor International Asset Management, Climate Bonds Initiative. Data as at 26/08/2019. Some green bonds in the index have Use of Proceeds overlapping across multiple categories.
4Lyxor International Asset Management, as at 01/12/2019. These indicators account for 43% of the portfolio weight, where data was available. AUM of fund at time of calculation was €160m. Further explanations on methodology and assumptions available on request.
4. Lowering costs
Green indexing that doesn't cost the earth
As we’ve mentioned before, improvements in the collection, cleansing and standardisation of ESG data mean that index providers can codify ESG objectives into benchmarks with a great degree of precision, rigour and transparency.
Managers of active green bond funds must charge higher fees to cover their research costs and analyst salaries. In contrast, the rules-based nature of index tracking ETFs helps keep costs for investors down. In the case of our green bond ETF range, our chosen index (built with Solactive) selects securities based on an initial starting universe of green bonds independently approved by the CBI.
In other words, our investors still benefit from the research and expertise of the CBI, a leading authority on the green bond market with over 60 employees, without incurring the higher fees they would from an active manager.
We believe that holding only CBI-approved labelled green bonds gives you credible and pure exposure to the market.
François Millet, Head of Strategy, ESG & Innovation
5. Diversifying exposures
A growing variety of issuer types
Another benefit of taking a passive approach to green bond investing is diversification. In the case of our ETF range, this is true on many levels.
Firstly, our exposures are global, covering issuers from developed economies like France, Germany, and the US, but also emerging markets like China, India and Brazil.5
Secondly, the underlying indices in our range select green bonds from a variety of issuer types, including sovereigns (e.g. Belgium), sub-sovereigns (e.g. City of Paris), supranationals (e.g. European Investment Bank), development banks (e.g. Asian Development Bank) and corporates across sectors (e.g. Apple, Bank of America, Iberdrola).5
Finally, as with similar global aggregate exposures, our funds diversify across maturity buckets, meaning duration levels are comparable to traditional benchmarks.
It’s worth noting that active green bond managers may claim to offer better risk-adjusted returns through fundamental analysis and proprietary ESG frameworks. However, our research shows that some active green bond funds are not averse to ‘closet tracking’, where a fund ultimately behaves just like its reference benchmark. Why pay for an index hugger when you can get the real thing for a fraction of the cost?
Video: Transitioning from brown to green
The biggest global emitters and the biggest polluters have an opportunity to transition their business model.
Serena Vento, Director of Fundraising & Partnerships at the Climate Bonds Initiative
5Lyxor International Asset Management, Solactive, as at 06/01/2020.
The fund that's changing the world
Put your money where your conscience is
If the climate emergency is an issue as close to your heart as it is ours, consider our innovative green bond ETF range to make a tangible, targeted impact.
Our $210m6 fund launched in 2017 was the first of its kind in the world. Since then, it’s been awarded the prestigious Greenfin label, a national certification for private investments in a green economy introduced by the French government following the COP21. The label solidifies its credibility as a fund committed to financing the green economy, as it demonstrates a high level of requirement for the ‘green’ quality of its underlying assets.
We also launched a variant of the fund which comes with an issuer-level ESG screen designed to exclude companies involved in fossil fuel and nuclear power, controversial businesses or which operate in violation of the UN Global Compact.
6Source: Lyxor International Asset Management, as at 23/01/2020.
How our chosen Solactive indices work
*Issuers from emerging markets retained in hard currency only (EUR or USD)
Source: Lyxor International Asset Management. For illustrative purposes only. Full index methodologies may be found at www.solactive.com