Should you invest in green bonds?

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As nations around the world seize on the build back better mantra and COP26 looms, green investment has been at the front of a lot of investors’ minds. 

Investors are chasing down opportunities to invest in responsible funds invested in shares. Figures from the Investment Association reveal that responsible funds took in £6.7billion in the first half of 2021 – £2.4billion more than the previous year.

But while most of the focus has been on green stockmarket-invested equity funds, green bonds are now starting to have their moment in the spotlight too.

Meanwhile, savers disappointed by the damp squib of 0.65 per cent-paying three year NS&I green savings bonds, which the rate was revealed on today, may be tempted by investment bonds instead.

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Green bonds are structured in the same way as traditional bonds but the money investors plough in is theoretically earmarked for projects explicitly working to tackle climate change.

Global issuance of green bonds has grown from around $40billion in 2015 to £225billion last year, as governments clamber to pull in cash and say they want to achieve net zero, yet this still makes up only a fraction of the overall bond market.

However, if demand for the UK’s first green gilt issuance last month is anything to go by, institutional investors are taking notice.

The UK government raised £10billion in its first issuance of green bonds last month, but it was heavily oversubscribed with orders hitting £90billion.

While the market is heavily dominated by institutional investors, there are some ways for everyday investors to gain direct access to green bonds.

There are plenty of funds and ETFs that offer exposure and the green savings bonds will be made available through National Savings & Investments.

We look at whether green bonds are worth adding to your portfolio.

The eagerly-anticipated NS&I green bonds

The recent UK green gilt issuance was limited to institutional investors, however everyday savers will soon be able to get in on the act with the launch of NS&I’s green savings bonds launching next month.

Unlike gilts, other government bonds and corporate bonds, these are a protected savings product, but after waiting ages for the rate to be confirmed savers could be forgiven for feeling disappointed.

The three-year fixed-term bonds will pay just 0.65 per cent. They will be available to buy online and savers will have the opportunity to invest between £100 and £100,000. Savers won’t be able to access the money until their account reaches maturity.

Savers will not be investing directly into green projects but effectively giving their cash to the Government to do so. Some critics have argued that the Government could raise money for projects more cost effectively through gilts to fund green spending priorities.

“‘Unless you feel passionately about lending the UK Government money for green projects, better returns are likely available elsewhere.’”  Jason Hollands, Bestinvest

Ultimately, the success of the NS&I bond will be determined by a combination of the interest rate and people’s good intentions.

However analysts think savers shouldn’t get too excited given the paltry rate. 

‘The very best rates available on conventional three year fixed bonds are currently around 1.8 per cent – all of which are substantially less than inflation,’ says Jason Hollands, managing director of investment platform Bestinvest. 

‘Unless you feel passionately about lending the UK Government money for green projects, better returns are likely available elsewhere.’

‘Why would savers lock their money away for three years for the same interest rate they can currently get in an easy-access savings account? This equation makes even less sense now the nation is looking down the barrel of an interest rate rise from the Bank of England, which will lead to a hike in savings rates,’ says Laura Suter, personal finance analyst at AJ Bell. 

‘Many had hoped that NS&I would leap to the top of the league tables with the new product and they could have a triple win: a great rate, a Government-backed product and putting their money to greener use, but that’s not the case. Instead the rate is not far off a third of the top-paying account on a three-year term.’

The key advantage of the NS&I green bonds is that as a savings product rather than an investment money put in will be protected, whereas green investment bonds could fall in value. 

> Check the best savings rates in our independent best buy tables 

What green bond funds are available?  

So if you want to ‘greenify’ your portfolio with some bonds what other options are there?

Funds and investment trusts are the obvious first port of call, as they will do some of the work of diversifying for you. 

‘As with most investments – especially bonds that require a lot of due diligence and research – retail investors are probably better off getting access to these bonds via a fund rather than trying to pick one themselves. That way they got diversification and fewer nasty surprises,’ says Darius McDermott, managing director of Chelsea Financial Services.

Green government debt is in its infancy – and like all other quality sovereign debt tends to be low-yielding –  so a green corporate bond fund might be an attractive option and there are plenty out there if you are willing to accept sustainable or ethical examples too. 

Hollands notes the Liontrust Sustainable Future Corporate Bond Fund, which invests in bonds issued by companies that meet sustainable criteria, and currently yields 2.89 per cent.

It is largely weighted to UK bonds with strong European exposure and its largest holdings include Standard Chartered, Vodafone and United Utilities.

The Rathbone Ethical Bond Fund, led by Bryn Jones since 2004, is another strong performer with a 3.38 per cent yield.

It has outperformed the IA Sterling Corporate Bond sector for over four years. Its holdings are largely financial, including a Lloyds bond which matures in 2035 and a bond issued by Scottish Widows which expires in 2043.

Its ongoing charge fee is 0.63 per cent while Liontrust’s fund charge is 0.59 per cent.

Other corporate green bond funds performing well include Aegon Ethical Corporate Bond and EdenTree Responsible and Sustainable Sterling Bond Fund, yielding 2.48 per cent and 3.38 per cent respectively.

For a passive option there are a handful of ETFs, including the iShares Green Bond Index Fund, the largest green bond fund with over $3billion in assets which has returned 3.52 per cent in the last three years. The Lyxor Green Bond (DR) UCITS ETF has returned 2.09 per cent in three years.

What about direct bonds?

Some direct green mini-bond investments are already available to savers, through platforms like Abundance Investment, which allows people to invest directly into councils and businesses making a green impact.

For example, Abundance has offered five-year green bonds with West Berkshire and Warrington councils – which it considers lower risk – with a fixed 1.2 per cent rate of return. 

Investors would be wise to weigh up if the risk for the extra return offered by such bonds is worth it set against the rate paid by the protected NS&I green savings bonds. 

Alternatively, earlier this year Abundance was offering investors the chance to back Sterling Suffolk, a company using glasshouse technology to grow tomatoes, with a 8 per cent a year return on 11 year bonds.

But investors should realise that this type of bond investing comes with risks. The bonds are designed to be held to maturity, are not listed on an exchange – such as the London Stock Exchange’s Orb market, and while Abundance has a marketplace for people to sell out early that requires another investor to want their bonds. 

Debentures and bonds on the Abundance platform are not covered by the Financial Services Compensation Scheme, so your capital is at risk.

Customers do have recourse to the Financial Ombudsman if they have a complaint and Abundance Investment, as a regulated investment crowdfunding platform is part of the FSCS scheme which covers investors for any losses from negligence in the event the platform was to go bust.

What to consider… and beware the ‘greenium’

If you’ve decided that green bonds might be a good addition to your portfolio, there are some things to look out for.

Firstly, remember that as with share investing you need a portfolio of bonds that gives diversification in case things go wrong. This is vitally important to anyone considering mini-bonds or retail corpororate bonds. 

Investing in a fund or trust will do some of the diversification work for you, but as these may be quite heavily targeted funds you may need to look for balance elsewhere.

Given there is no universal certification for green bonds, which has led to some claims of greenwashing, you should look closely at both the projects which will be funded with the proceeds and the issuer.

‘The issuer itself does not necessarily need to have strong ESG credentials. That doesn’t mean it can’t be a green bond, but it might not fit all strategies and there may be question marks over motivations if corporate strategy is misaligned with those objectives,’ says McDermott.

‘Secondly, as M&G pointed out to me, it is a market which is self-labelled: following governance and reporting practices set by bodies such as the International Capital Markets Association (ICMA) is voluntary. 

‘This means that bond investors need to perform some due diligence to ensure that the ESG targets set are in the spirit of their investment philosophy.’

“There is a concept of ‘greenium’ in the marketplace today which often means green bonds will trade at lower yields ” Nachu Chockalingam, Federated Hermes

As well as assessing the issuer and use of the proceeds, investors should also consider whether the returns are as good as a bond that is not labelled green.

For example, the UK’s green gilt issued last month was priced at a yield of 0.87 per cent. 

The bond, which matures in 2033, can be purchased on the secondary market but is currently yielding 0.9 per cent, less than conventional gilts currently yielding 1.15 per cent.

Nachu Chockalingam, senior credit portfolio manager at Federated Hermes, said: ‘There is a concept of ‘greenium’ in the marketplace today which often means green bonds will trade at lower yields than non-green or sustainable bonds of the same issuer because of their greater demand – and we, as investors, need to make the judgment call if that is right.’

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