ESG Bonds: How to Support ESG Projects & Earn a Fixed Income

Written by

Justin Kuepper

Published on

Jan 20, 2022

Last updated

Jan 30, 2022

Environmental, social, and governance (ESG) funds could become a $1 trillion business by 2030, according to BlackRock's Armando Senra. While ESG stocks capture the most investor attention, ESG bonds represent a much larger market. In fact, the Climate Bond Initiative reckons that the green bond market is already worth more than $1.2 trillion.

While ESG bonds are popular among institutional investors, most everyday investors have limited experience investing with bonds, given their high minimums and lack of research. For example, a diversified bond portfolio might cost $100,000 to set up because of the $10,000 minimum per bond—a huge ask given that $65,000 median retirement portfolio!

In this article, we'll take a look at why everyday investors might want to consider ESG bonds, the easiest way to find and purchase them, and some alternatives to consider.

Why Invest in ESG Bonds?

ESG bonds enable investors to financially support projects that meet ESG standards. But, of course, everyone has a different definition of what constitutes ESG standards. Fortunately, the International Capital Market Association (ICMA) developed a uniform standard defining specific ESG criteria and reporting requirements.
The ICMA defines four types of ESG bonds:

  • Green bonds finance new or existing renewable energy or sustainability projects. For example, a bond financing a utility-scale solar array would be a green bond.
  • Social bonds finance new or existing projects targeting a positive social outcome. For instance, a bond financing affordable housing developments would be a social bond.
  • Sustainability bonds are a combination of green and social bonds.
  • Sustainability-linked bonds aren't explicitly earmarked for sustainable projects but generally support ESG-aligned activities.

Each type of bond has its own set of ICMA standards, including the Green Bond Principles (GBP), Social Bond Principles (SBP), Sustainability Bond Guidelines (SBG), and Sustainability-linked Bond Principles (SLBP). These standards spell out everything from how issuers can use the funds to how often they report their progress to investors.

ESG bonds may be issued by corporations, government agencies, and global organizations to finance a wide variety of projects, such as:

  • Wastewater management
  • Public transportation
  • Wildlife preservation
  • Pollution remediation
  • Renewable energy
  • Affordable housing

Many ESG bonds also provide tax-exempt income, similar to municipal bonds, and may have lower default risks than other bonds. These attributes make ESG bonds attractive financially while supporting causes investors care about most. It's a win-win scenario for investors and issuers looking to make a difference in the world.

How to Find ESG Ratings for Bonds

Most investment-grade bonds have credit ratings from rating agencies, such as Standard and Poor's, Fitch Ratings, or Moody's Investor Service. But unfortunately, these ratings are proprietary and hard to come by for everyday investors. The good news is that a growing number of services help connect investors with highly-rated ESG bonds.

Popular ways to find bonds with strong ESG ratings include:

  • NASDAQ Sustainable Bond Network - The NASDAQ Sustainable Bond Network connects issuers of sustainable bonds with investors, providing standardized data in one place.
  • Sustainalytics - Sustainalytics provides ESG ratings and other information to help investors assess the impact of bonds and other investments, including equities.
  • Fannie Mae Bonds - Fannie Mae is one of the largest green bond issuers in the world and provides an easy-to-use portal to help investors identify vetted opportunities.

When choosing an ESG bond, it's critical to employ the same due diligence as you would for conventional bonds, such as:

  • Credit Rating - Credit ratings reflect the risk that the issuer goes bankrupt or cannot make bond payments.
  • Duration - Duration refers to the bond price's sensitivity to interest rates, which is critical during inflationary environments.
  • Yield - Yield is how much you can expect to earn from the bond over time through coupon payments.
  • Callability - Callability refers to the issuer's ability to buy back the bond from an investor.

Investing in ESG Fixed Income Funds

ESG fixed income funds provide a much easier way for everyday investors to participate in ESG bonds. Rather than building a portfolio of bonds from scratch, these funds offer instant access to a pre-built and professionally-managed portfolio. You can also invest with a far lower amount of capital, ensuring that you have proper diversification.

Some popular ESG fixed income funds include:

  • TIAA-CREF Green Bond (TGRNX) - The fund maintains a portfolio of ESG bonds that have a direct impact, such as renewable energy or the redevelopment of contaminated sites. These attributes make it one of the most popular ESG bond funds in the market.
  • iShares ESG U.S. Aggregate Bond ETF (EAGG) - The fund adds an ESG adjustment to the corporate bond sector, removing issuers with the lowest ESG scores. In other words, it takes an "exclusionary" rather than an "inclusionary" approach to ESG.
  • PIMCO ESG Income Fund (PEGAX) - The fund invests in a diverse portfolio of income-generating bonds within a socially-conscious framework. In addition to using ESG criteria, the fund engages with issuers to realize ESG-related objectives.

There are a few significant factors to consider when choosing an ESG fixed income fund:

  1. Ensure the fund offers the impact and financial return you expect.
  2. Look at the fund's expense ratio to see how it impacts your returns.
  3. Consider the fund's portfolio to ensure diversification.
  4. Evaluate the duration and credit quality of the fund's portfolio.

Alternatives to ESG Bonds

ESG bonds aren't the only way to generate fixed income from ESG-focused opportunities. With the rise of crowdfunding, there are a growing number of platforms providing investors with unique opportunities to make an impact. Many of these opportunities also offer compelling returns and even equity components (e.g., preferred stock).

Some popular ESG bond alternatives include:

  • CNote is a women-led B Corp that invests in programs to create jobs, fund BIPOC-owned small businesses, and support affordable housing development. Investors can purchase notes with interest rates of 2% and access quarterly liquidity.
  • Steward enables investors to lend to small sustainable farms, ranches, fisheries, and producers, providing them with the capital they need to grow while earning up to 10% interest rates. 
  • Small Change provides access to private real estate deals supporting urban revival, affordable housing, and other causes with attractive returns and low minimum investment.

You can find more information on these and other ESG bond alternatives on VirtueScout, spanning renewable energy, sustainable agriculture, affordable housing, and numerous other impact areas. You can also find opportunities for crowdfunded equity, banking products, and different ways that you can make a bigger impact with your finances.

The Bottom Line

ESG bonds enable investors to finance ESG-related causes and generate a fixed income. While individual bonds are hard to invest in, ESG fixed income funds provide a great alternative. Investors may also want to consider impact notes and other forms of fixed-income investments to support the causes they care about most.