ETF Expert Corner

VanEck’s Bill Sokol Spotlights Vectors Green Bond ETF (GRNB)

June 20th, 2017 by ETF Store Staff

Bill Sokol, ETF Product Manager at VanEck, explains the idea behind green bonds and spotlights the VanEck Vectors Green Bond ETF (GRNB).

Play


Transcript

You can listen to our interview with Bill Sokol by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the VanEck Vectors Green Bond ETF, ticker symbol GRNB. This is the first U.S.-listed fixed income ETF offering exposure to the green bond category and joining us via phone from New York to discuss this ETF is Bill Sokol, ETF Product Manager at VanEck. Bill, a pleasure to have you on the program today.

Bill Sokol: Thanks, Nate. Great to be here.

Nate Geraci: Bill, my sense is many of our listeners are probably unfamiliar with green bonds, so to begin here today, give us some background. What exactly are green bonds?

Bill Sokol: It's a great place to start. A green bond is really like any other bond, but the difference is that the proceeds are used only to finance projects that have a positive financial impact, so those projects could be things like renewable energy, so solar and wind projects, it could be energy efficient buildings, it can be mass transits. Also, interestingly, it can be projects that maybe a city or a state undertakes to build resilience to climate change, so to adapt to the changes that are already happening. But the focus is really on disclosure and transparency. A green bond is not a new type of debt instrument. It's just about disclosure, it's about ring-fencing of the proceeds and ongoing reporting, and I think it's important to note that in the vast majority of cases, these are really just plain vanilla bonds that are backed by the full balance sheet of an issuer. So a company like Apple, for instance, has issued green bonds but from a fundamental risk and return perspective, all else the same, there's no difference between a green bond and let's call it a non-green bond, except for this additional disclosure that you get with the green bonds.

Nate Geraci: Can you talk a little bit more about that in terms of who determines whether a bond is green or not because it certainly seems like there could be some subjectivity here?

Bill Sokol: There can be. So in the one sense, a green bond is really defined, even the market defines it right now as a bond who uses the proceeds that go to an environmentally friendly project, and that makes the required disclosures, and that's what's called a green label. So if an issuer believes that they're financing environmentally friendly projects and they provide this information to investors, they can self-declare the bond as green. Now, for a lot of investors, for ESG investors, that's not enough because you do have the risk that an issuer could call a bond green and then use the proceeds for some project that maybe is not green, so what we did with GRNB is it tracks an index, the S&P Green Bond Select Index, and the way that green bonds are evaluated is really baked into the methodology of the index. So the starting point is to look at this universe of green labeled bonds and just make sure that there is the right level of transparency, but then on top of that, it looks to an organization called the Climate Bonds Initiative, which is an independent third party - it's actually an NGO that's based in London - and their sole mission is really to help grow the global green bond market. It's an organization that's really taken the lead on developing standards around what green bonds are, so that would help remove this subjectivity that you mentioned. So what they do is they've built a classification system that includes projects which are considered to be green-based on their research base and scientific framework that they develop with climate experts around the world and really it's built with the goal of reducing greenhouse gas emission, so that global warming can stay below 2 degrees Celsius, which is a goal that was agreed by almost every country in the world a few years ago under the Paris Agreement, which has been in the news lately. But it is designed around that goal so it does include a specific type, specific project types, and as long as it is flagged as green by the the Climate Bonds Initiative then, in the case of GRNB, it would be eligible for index inclusion. So it really provides that integrity that I think ESG investors want and really need to be confident that their green bonds really are having the environmental impact that they're looking for.

Nate Geraci: Bill, I'm curious, overall how big is the green bond market?

Bill Sokol: So today it's around $200 billion of outstanding issuants, but the market's grown tremendously. You know, this market really began in 2007, so just 10 years ago, with a single bond issuant in Europe from the European Investment Bank, which was a supranational issuer. From that single bond in 2007, what we have seen is really exponential growth over the last few years, since 2013 in particular. Just to give you an idea, so last year, in 2016, there was over $80 billion of issuants, which doubled the size of the market, so it's now worth about $200 billion. Expectations this year are from anywhere from probably 120 to 150 billion dollars of additional issuants.

Nate Geraci: Our guest today is Bill Sokol, ETF Product Manager at VanEck. We're spotlighting the VanEck Vectors Green Bond ETF, ticker symbol GRNB. Bill, you started to talk about the construction of GRNB, I'd love to hear some more detail - just in terms of number of holdings, if there are any weighting caps, anything else noteworthy about the underlying construction of this ETF.

Bill Sokol: Sure. So, I mentioned how the index evaluates whether a bond is green or not green. From there, you have an eligible universe and then there are some additional filters that are applied that are really built in to enhance trading and liquidity - so you can kind of screen out the bonds that you can't really purchase, they're too small, perhaps, so there's some size filters. The index does require a rating. They have to be bonds that are actually accessible to a global bond investor and then on top that, we do include a 10% issuer cap, or I should say S&P includes that issuer cap, which we thought was important because it is still a new and growing market and you don't want to be overly concentrated in any one issuer. Lastly, there's a 20% cap on high yield, which really the green bond market isn't anywhere close to. It's a very high quality market but, again, we thought it was important to build in these safeguards because you don't know how the market could look in the future, considering the growth that we're seeing. Basically, what you're left with is a very global portfolio, and it's multi-sector. Right now in the fund there are about 41 bonds and, like I said, it's actually quite diverse. It's multi-sector, you have about a third in government and government-related issuers, you have about a third in financials - so banks are very large green bond issuers - and then you have a third in corporate bonds. I think utilities - you'd expect them to be a natural player in this space, but you also have tech companies and consumer oriented issuers as well. Like I said, it's multi-currency, which is really reflective of the very global nature of the green bond market. High quality - overwhelmingly it's an investment grade index - so I think about 95% investment grade. Substantial amount in triple-A, which is reflective of the large presence which supranational issuers have, so these are triple-A rated entities that are very active bond issuers. Basically, what you're left with is an exposure that, in many ways, resembles a core global bond allocation, something like the Global Agg Index in terms of quality, in terms of yield and duration. You don't have a substantial difference with the Global Agg Index, so it's interesting the way the market's developed and, yes, it's grown, it's really grown in terms of diversity as well, to resemble the global bond market.

Nate Geraci: Bill, as I look at the top holdings in this ETF, currently the top holding is a French Republic Government Bond Issue, this actually comprises about 8% of the ETF’s total assets. I thought it might be interesting - can you tell us more about this specific issue?

Bill Sokol: Yes, absolutely. So France, earlier this year in January, issued a 7 billion Euro green bond, which was by far the largest green bond issued to date by any type of issuer. It was the second country to issue a green bond, the first one was Poland and I believe it was December in 2016. So a month later, France issued their bond, which was really quite a development for the green bond market - to see sovereign issuers enter the market, so that was a very successful issuant, so 7 billion Euros, they actually just upsized that and did another, I believe, 1.4 billion Euros within the last two weeks. It’s coming from a country that is really a leader in terms of their stance on climate change policy, so I think the green bond is meant to be a demonstration of that leadership, and what that bond will go to finance is really a wide variety of projects and initiatives in France. They've outlined climate change adaptation and mitigation projects, so quite a wide variety, but also some projects around preservation of ecosystems, and also pollution control.

Nate Geraci: We're visiting with Bill Sokol, ETF Product Manager at VanEck. Bill, from a portfolio standpoint, where does GRNB fit in a portfolio? Is this a core holding and what does the general risk/return profile look like?

Bill Sokol: Sure, so I kind of went through what some of the main characteristics of what the green bond market looks like and some of GRNB’s characteristics and so what you see is something very similar in many ways to a global aggregate core bond exposure. From a portfolio construction perspective, you can have a pretty seamless allocation within that core global allocation without impacting your risk/return profile. From another perspective, if you maybe have a more U.S.-centric portfolio, it would give you the diversification that you get with global bond investing, from exposure to other countries, other types of issuers and other currencies as well. So we do see it as part of a core allocation, whether it is coming out of a, maybe, a global bond portfolio or diversifying your U.S. exposure. I think there's another interesting element with green bonds from a portfolio construction perspective, which is as a risk diversifier, because I'm not talking your traditional interest rate risk, credit risk. What I mean by that is with green bonds you're getting a broad exposure to global issuers that are really taking a strategic approach to the way they address and mitigate climate risk in their operation. And those are risks that you don't necessarily get - they're not necessarily reflected in traditional bond portfolios. I think that climate risk is still not really top of mind for investors, but to the extent that you see climate risk maybe begin to get assessed more by investors and maybe priced in, I think green bonds can provide a hedge to the extent that those issuers are really being proactive in the way that they manage their own climate risks. Right now, given that your yield and duration are in line with a core global bond allocation, you're really not even paying for that hedge, so, again, we do see it as part of that core bond portfolio.

Conor Kelly: Bill, this is Conor Kelly. We're running out of time here, but one last question for you. Does the issuer of the project matter? For instance, what if Exxon Mobil or an oil company had a project that was labeled green? Would that still fit in the index even if the underlying issuer might not be perceived as a, quote/unquote, green company?

Bill Sokol: Yes, so that's a great question and the green bond market has really developed to really emphasize transparency, disclosure and it really all comes back to use of proceeds of a particular bond issue rather than assessing the operations of the issuer itself. It's a very inclusive way of investing. It's not the exclusionary style of ESG investing that you might see sometimes, where you exclude certain types of companies. With green bonds, it's much more inclusionary, so as long as the bond itself is financing projects that are truly green, it is considered a green bond and there are several examples of I think what some people call brown companies issuing green bonds. Here in the U.S., several utilities, so power producers, have issued green bonds very successfully. Southern Power, Mid-American and some others, have issued green bonds to finance renewable energy projects. On the other hand, we have seen, just very recently, a large European oil and gas producer issue a green bond that went to finance their refinery operations, to make them more efficient and a lot of people looked at that and said, "Well, you're not really transitioning to a low carbon economy by making your gas refineries more efficient." So that was viewed very skeptically. You know, our index and most indexes excluded that green bond. Again, not because it's an oil and gas producer, but because the bond itself wasn't viewed to be financing environmentally friendly projects.

Nate Geraci: Well, Bill, with that we're going to have to leave it there. Just an excellent ETF spotlight today. I think it will certainly be interesting watching this segment of the ETF market continue to expand and I do think the VanEck Green Bond ETF was a much needed addition. Thank you for joining us today.

Bill Sokol: Thank you. My pleasure.

Nate Geraci: That was Bill Sokol, ETF Product Manager at VanEck and if you would like to learn more about the VanEck Green Bond ETF, you can do so by visiting vaneck.com.