The following content is sponsored by Wells Fargo Asset Management.
ESG Municipal Bonds: The Next Sustainable Opportunity
When you think of sustainable investing, does your mind immediately go to stocks? Sustainable investing may have started in equities, but it’s now expanding into a variety of specialized asset classes—including municipal bonds.
In this infographic from Wells Fargo Asset Management, we highlight the growth of ESG (environmental, social, governance) municipal bonds and how investors can identify them.
A Growing Shift to ESG Bonds
Over the past decade, ESG municipal bond issuances have had a compound annual growth rate (CAGR) of more than 70%.
|Year||Green and social municipal bond issuance|
Source: Morgan Stanley Research, Bloomberg
Issued by state and local governments, these bonds often have a positive impact on society or the environment. For example, ESG municipal bonds can be used for affordable housing or renewable energy.
Which factors are propelling their growth?
Amid pandemic-related volatility, credit rating agencies have highlighted the importance of non-financial risk factors. From April to November 2020, 33% of credit rating actions among U.S. public finance entities were related to ESG. To mitigate risks, a growing number of investors are adopting sustainable strategies.
Calls for equity have put a focus on investing in underserved communities, such as those with low-income populations or higher proportions of people of color. ESG municipal bonds can help finance initiatives such as accessible education, access to basic services, and quality healthcare.
Climate change adaptation
Many municipalities are exposed to physical risks such as flooding and fires, but few currently disclose them. As a result, there is a push for issuers to provide more disclosures, and explain how their bonds will mitigate these risks. For example, a municipality facing flood risk could issue a bond to upgrade storm water management.
It’s clear that global trends are accelerating the shift to ESG municipal bonds. But how can investors determine which bonds are sustainable?
Identifying ESG Municipal Bonds
Traditionally, investors can seek green or social-labeled bonds—but these securities only make up 2% of the market. Investors who follow this approach have been missing substantial opportunities, as many sustainable bonds don’t have a green or social label.
Fortunately, there’s another option. Investors can follow Wells Fargo Asset Management’s (WFAM) positive impact framework, which includes sustainable bonds if they meet at least 1 of 3 main criteria.
- Use of proceeds: Are the bond’s proceeds used for a project that offers tangible environmental or social benefits?
- Issuer ESG Impact: Does the bond issuer provide environmental or social benefits through their services or operations?
- Underserved population: Does the bond issuer serve an underserved population group?
By applying the positive impact framework to an existing municipal bond portfolio, more than two-thirds of the bonds demonstrated positive sustainability attributes.
How does this approach work in practice? Consider two bonds issued by the same county.
|Bond A||Bond B|
|Type||General obligation*||General obligation*|
|Use of proceeds||Flood control infrastructure||Sports stadium enhancements|
|Sustainable outcomes expected?||Yes||No|
*General obligation bonds are backed by the credit and taxing power of the issuer, rather than from the revenue of a specific project.
While both are general obligation bonds, only the bond expected to drive sustainable outcomes (Bond A) is included.
Using this framework, investors can go beyond labels to identify a wide array of ESG municipal bonds. Not only that, the ESG municipal bond market is expected to grow, from a total issuance of $19.7 billion in 2020 to a projected $30.0B in 2021.
Issuance of ESG municipal bonds is likely to increase to supplement federal financing. The Biden Administration has pledged a $2 trillion dollar investment in sustainable infrastructure, including water systems and roads & bridges. New, greener opportunities are on the horizon.
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