Interest in investments that support environmental and social impact objectives is growing rapidly among both institutional and individual investors. This is particularly true with respect to the retail-focused municipal bond market. Every week we see an increasing number of new municipal bond issues – both tax-exempt and taxable with a “Green Bonds”, “Social Bonds” or “Sustainability Bonds” label.
Bloomberg data indicates that Municipal Green Bond issuance alone increased by 65% from $11.093 billion in 2019 to $18.359 billion in 2020. Earlier this year Standard & Poor’s estimated total municipal sustainable debt issuance (including all three categories) of $30 billion for calendar year 2021.
These imprimaturs are only provided after third-party verification of multiple characteristics of the offering with a focus on use of proceeds, project selection, allocation, and management of proceeds, reporting on use of proceeds and other factors. Environmental and social impact criteria and category checklists are available from multiple organizations with the Climate Bond Initiative, International Capital Markets Association Green Bond Principles and United Nations Sustainable Development Goals all providing a robust menu for review.
So how can financial advisors best help their clients navigate the ESG municipal bond world? The number one thing to do is to carefully LISTEN to their clients.
Despite the rip-roaring equity market of the past 10 years and the current low fixed income yield levels overall, individual investors rightly continue to consider municipal bonds as an integral part of their portfolios because of several benefits -- particularly diversification, credit quality and tax-advantaged income. A municipal bond manager can assist the advisor in meeting the objectives of their client, starting with an “inventory” of the financial parameters of the client’s investment objectives including income, appreciation, liquidity requirements, and credit risk tolerance.
But with strong investor interest in blending ESG considerations into their investment strategy it is critical to carefully inventory a client’s environmental and social impact parameters as well. Is the client focused on renewable energy, affordable housing, education, health care or other sectors? Are they especially passionate about one or more sectors? Are there particular industries, specific borrowers, or locations that they wish to avoid?
If the client does not have particularly strong positive or negative criteria for their ESG parameters, then the municipal manager can search for bonds in a larger universe of potential investments based upon broader sectors and criteria and the client will likely be pleased. But an open initial discussion can importantly help determine the client’s fuller and deeper views and may require the municipal manager to take a more “customized” approach. For example, while hydropower may check the renewable energy box for many, for some individuals the negative impact to fish habitats caused by the necessary dams, makes such projects unacceptable. Are they comfortable with managed lane projects in the transportation sector? Some view these projects favorably because they reduce traffic congestion and related pollution, while others prefer to avoid anything related to a combustion engine and prefer transportation investments with a mass transit focus. Would they prefer more focus on clean water or waste management?
A municipal bond manager can help advisors to meet the challenge to construct a portfolio that will successfully meet both the financial parameters and the environmental and social impact parameters desired by the client. While the manager might identify a multi-family housing project that fits the client’s impact criteria, it might be financed with too small a bond issue, with very limited liquidity. It would be difficult to monetize and therefore would be a good match to a total return objective that may be part of the client’s financial parameters.
Balancing the dual parameters is not easy. The client, advisor and municipal manager will certainly all bring their own independent opinions about the world --- political issues, social issues, and other topics --- to the relationship. The task for the municipal manager is to work with the advisor to understand the client’s objectives and then attempt to build a portfolio that meets the articulated dual parameters as best as possible. Ongoing dialogue is important. Discussions about adjustments in criteria may be warranted periodically based on market conditions and particular opportunities and risks that may be identified. But it all starts with listening.
David Falk and Bill Mock are fixed income portfolio managers at Shelton Capital Management.
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