We look at two London-listed products that provide exposure to a hot part of the market

For investors worried   about the stock markets, bonds can be useful alternative. And if you want to invest ethically, a nascent area of the bond market – green bonds – could be the answer, particularly if they’re wrapped in an easy to invest way like an exchange-traded fund (ETF).

Green bonds are investment bonds that are ring-fenced to fund projects that specifically have positive environmental and/or climate benefits, as defined by the Climate Bonds Initiative (CBI), a not-for-profit organisation.

In theory, investing in green bonds – particularly through ETFs given they package lots of them together for a relatively low price – can be the most effective way of putting your money to good use ethically, while still hopefully getting a decent return.

After all, the cash raised from such bonds has to go to projects that help improve the environment and protecting the planet so in future we all have a world to live. That’s arguably as ethical as it gets.

There will be undoubtedly be more funds available as this area grows, but for now investors in the UK have two main options – a traditional passive product, the  Lyxor Green Bond ETF (CLIM), or the actively-managed Franklin Liberty Euro Green Bond ETF (FVUG).

TAKING THE PASSIVE ROUTE

Lyxor was the first ETF provider to launch a fund in the green bond space in 2017, and Adam Laird, the firm’s head of strategy for Northern Europe, explains its ETF was set up to give investors a way to invest in ESG but without the riskiness typically associated with shares.

He says: ‘It is difficult to get diversification with ethical investments, so we thought green bonds were a good way to do that.’

As with any market in its early stages, the perception is that there’s more risk involved, but Laird points out that all the bonds are investment grade and come from big institutions.

The ETF aims to track the Solactive Green Bond EUR USD IG Index, which is made up of euro and dollar denominated green bonds issued by governments, supranationals, development banks and big corporates.

He adds: ‘It’s not a guarantee of a return, but the green finance market has money to be invested, and it opens doors for other issuers to come to market.’

At a total expense ratio of 0.25%, the ETF is averagely priced compared to global bond ETFs and it has delivered a return of 7.5% in the first half of this year.

TAKING THE ACTIVE ROUTE

Franklin Templeton’s active ETF has ongoing charges of 0.3% a year, which is on the lower end of the scale for such actively-managed exchange-traded funds.

Caroline Baron, head of ETF sales at Franklin Templeton, says the fund is actively managed because green bonds are a new area of fixed income, so the asset manager sees an opportunity to achieve better returns by picking and choosing the bonds to put in the portfolio.

She adds that since the fund was launched in April, the bonds in the portfolio tend to be less volatile than traditional bonds, as the duration – the time before the bond matures – is typically longer than ordinary bonds.

Unlike the Lyxor ETF, Franklin Templeton’s product is comprised 70% of green bonds with a certified stamp from the CBI allowing them to be called green bonds, and 30% in so-called ‘climate aligned’ bonds, which are similar but don’t have the CBI stamp.

An example of a climate-aligned bond is Standard Chartered’s sustainability bond, with money it gets going towards various projects in Asia and Africa which aim to tackle global issues like poverty, inequality and prosperity.

ISSUES TO CONSIDER

Since the first green bond was launched in 2008, the area has grown significantly and has no shortage of investors keen to get involved.

But Matt Brennan, head of passive portfolios at AJ Bell, warns if ESG is on your mind with these ETFs – buyer beware.

‘What’s difficult from an ESG point of view with these green bonds is that they’re not defined at a company level, but how the bond is used,’ he says.

While many might think these bonds are going to specialist renewable energy companies for example, it may come as a surprise that most of the bond issuers are actually governments and financial institutions, as well as energy companies which still generate money from fossil fuels.

GREEN CREDENTIALS

One of the top holdings in Lyxor’s fund is utility provider EDF, which generates around 8% of its revenue from coal and 9% from gas, while the majority (71%) comes from nuclear, a controversial form of renewable energy which has had its green credentials questioned.

Brennan adds: ‘Even though the proceeds of the bonds are being used for green purposes, you’re still giving finance to companies that are doing the complete opposite to green projects. You’d never get that on an equity basis.’

For ESG investors, the argument for adding fixed income to the portfolio is to lower the risk, but Brennan argues that investing in sustainable companies by their very nature should be less risky.

He says: ‘If the sustainable filter is genuine, these companies should be less risky as their business models should make them less susceptible to things like financial fraud which can bring a company down.

‘And in the long-term sustainable companies are less likely to have profit warnings. But the jury’s out on whether that’s the case as it is still early days.’

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