Shades of Green in the Bond Market (Part 1)

Most bond ETFs that emphasize ESG criteria are limited to applying them to the nonsovereign portions of their portfolios.

Morningstar ETF analysts 07 April, 2021 | 18:06
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ESG integration in bond funds is difficult. ESG-relevant data is often sparse and inconsistent. It also involves trade-offs. ESG integration introduces active risk that may or may not be rewarded. ESG-intentional bond funds navigate these challenges in a variety of ways. Here, I’ll examine a sample from the menu of ESG-intentional bond exchange-traded funds to illustrate these issues.

It’s Not Easy for Bond Investors to Be Green

Investors aiming to incorporate ESG criteria in fixed-income portfolios face many of the same challenges as equity investors. These issues range from whether ESG risks are better managed via ownership and engagement or through exclusions, to whether ESG is a factor in and of itself.

Perhaps the greatest challenge facing investors wanting to fold ESG criteria into their bond portfolios is the makeup of the bond market itself. As of the third quarter of 2020, U.S. Treasuries accounted for about 40% of market value of the total U.S. bond market, as measured by the Securities Industry and Financial Markets Association.1 Another 20% of the market comprised securitized bonds issued by Ginnie Mae, Fannie Mae, or Freddie Mac. Consequently, about 60% of the U.S. bond market points back to a single issuer: the United States government. Scoring sovereigns on their ESG performance is a difficult and politically thorny issue. As such, ESG analysis and scoring in the bond market has been focused primarily on corporate issuers. As a result, most bond ETFs that emphasize ESG criteria are limited to applying them to the nonsovereign portions of their portfolios. Within this narrower slice of the bond market, investors face the same challenges as equity inves­tors: a lack of quality, standardized data to reliably measure issuers’ ESG risk. But the market is always evolving, as are investors’ options within the realm of sustainability-focused bonds and the funds that invest in them. For example, more bonds are being issued for the express purpose of financing ESG-friendly investments. The largest subset of these is known as green bonds.

Green Bonds

The use of proceeds from green bonds is specifically and measurably tied to projects benefitting the environment. According to the International Capital Markets Association, these projects might include those aimed at climate change mitigation, climate change adaptation, natural resource conservation, biodiversity conservation, and pollution prevention and control.

The green bond market has existed for more than a decade, but it was largely dormant until recently. In 2007, the market comprised fewer than 200 bonds with a total market value of just US$10 billion, using the ICE Bank of America Green Bond Index (hereafter the Green Bond Index) as a proxy. At the end of February 2021, the index counted 750 bonds as constituents with a total market value of US$625 billion.2

Corporate bonds are the largest cohort within the Green Bond Index, accounting for half of the market’s value. The largest corporate issuer included in the index is Engie SA, a French utility provider. Quasi-government issuers, such as the European Investment Bank, make up the second-largest cohort, accounting for a third of the market’s value. Sovereign issuers are the smallest segment, representing 15% of total market value. That said, the largest issuer in the Green Bond Index is the French government, which accounts for 7% of the market. Indeed, European issuers dominate the market.

Entering March 2021, euro-denominated bonds accounted for 65% of the Green Bond Index, while U.S.-dollar-denominated debt comprised just 20%. Therefore, exposure to the green bond market requires U.S. investors to either draw from a narrow slice of the opportunity set or accept some degree of (or hedge) currency risk. Regardless of how investors approach it, investing in green bonds entails a large amount of active risk, as the green bond market accounted for just 1% of the ICE Global Broad Market Including China Index as of the end of February.

There are currently two ETFs providing exposure to green bonds in the U.S. VanEck Vectors Green Bond ETF (GRNB) tracks the S&P Green Bond U.S. Dollar Select Index, which includes U.S.-dollar-denominated bonds that are labeled as green bonds and issued by supranational, government, and corporate issuers from around the world. The second, iShares Global Green Bond ETF (BGRN) tracks the Bloomberg Barclays MSCI Global Green Bond Select (USD Hedged) Index, which includes non-U.S.-dollar-denominated bonds.

In Part 2 of this article, we will explore the differences of these two funds.

1 Fixed Income Outstanding retrieved March 8, 2021, from resources/research/fixed-income-chart/

2 Junk-rated bonds, excluded from the Green Bond Index, account for a small slice of the green bond market. (

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