Responsible Investing is a relatively new concept in the municipal bond market, but we believe it's well-suited to a market that finances entities and projects intended to serve the public good.
Responsible Investing incorporates environmental, social and governance (ESG) factors into the investment process through credit analysis and portfolio construction. The goal is to align investments with the values of socially conscious investors through programs and projects that contribute to local communities in a positive way, such as:
- Renewable energy projects.
- Infrastructure for clean drinking water and sustainable waste projects.
- Public education facilities in underserved communities.
- Not-for-profit hospitals and other health care facilities.
- Affordable housing.
- Land conservation.
Determining which muni bonds qualify for ESG portfolios
Responsible Investing is not just about avoiding investments deemed to have a negative impact. Equally important is investing to achieve a positive impact on society -- and this must be done in a manner that produces competitive investment results.
ESG standards incorporate the long-term sustainability of a project and the possibility of lower costs, lower waste and more efficiency over time, which will contribute to underlying credit strength. Research suggests that implementation of sustainable practices can create efficiencies to improve investor value and mitigate risk over time.
For example, a city in North Carolina issued bonds to replace asbestos water pipes throughout its water system with 100% recycled ductile iron pipes designed to last over 100 years. The project should limit/eliminate system water loss, increase water transmission efficiency and improve the quality and safety of drinking water. Initiatives like this that increase sustainability of water and sewer systems, conserve natural resources, or improve energy efficiency could increase savings for state and local governments in the long run.
Green muni bonds: An evolving opportunity
Green bonds, like the North Carolina issue mentioned earlier, are municipal bonds with proceeds used specifically to fund environmentally beneficial projects. They allow investors to support climate-aligned projects in expected sectors such as transportation, water and waste infrastructure, pollution control and renewable energy (wind and solar power), but also in sectors such as education, health care and affordable housing.
We believe that green bonds will become a common building block of ESG municipal portfolios since they allow environmentally conscious investors to enjoy the benefits of municipals, such as tax-exempt income and capital preservation. As with all municipal bonds, we believe careful credit analysis is necessary to avoid challenges and uncover value. With green bonds, additional analysis of the projects and the ongoing use of proceeds is also important.
Investor interest has encouraged the green municipal bond market to grow significantly. As of 2017, it was approximately $25 billion. With about $11 billion of that issued in 2017, another $16 billion is expected for 2018.
While green bonds are a rapidly growing segment of the municipal bond market, the market's definition of a green bond is still evolving. Continued strong demand should result in the creation of widely accepted metrics. We believe that soon the ratings agencies will standardize their green bond ratings.
Bottom line: We see increasing opportunity within the municipal bond market for investors interested in purchasing bonds according to ESG principles to invest with meaningful social and environmental impact. Through careful credit analysis and portfolio construction, municipal bond investors can integrate an ESG focus and align their investments and values without sacrificing credit quality or performance.
An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Rising interest rates could reduce the value of the bonds in the portfolio, thus adversely affecting the value of the overall investment.
© Eaton Vance
© Eaton Vance
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