This article first appeared in the November 2023 issue of the GreenMoney Journal and is reprinted here with permission. Learn more at greenmoney.com.
When thinking about ways to help the planet and its people, investments in fixed income rarely come to mind — but they should! No longer are bonds just the sleepy, safe, under-attended corner of one’s portfolio. Today impact-targeted fixed income (or “impact bonds”) offer a rapidly expanding opportunity to directly support the type of change you are seeking in the world. At Praxis Mutual Funds®, we’ve grown our use of these bonds from 12% to 36% over the past 10 years, while still maintaining a broadly diversified fixed income portfolio. This mirrors the explosive growth and innovation we’ve seen in the green, social, and sustainable bond space as a whole during this period — including product that supports the green building movement.
The evolution of impact in fixed income investing
I began thinking about the possibilities for positive impact bonds back in 2006 when the International Finance Facility for Immunisation (IFFIm) issued a bond that served to dramatically increase the rate of immunization against critical diseases in the developing world. The direct connection between the bond investment and the impact on lives was incredibly clear. Through the Praxis Impact Bond Fund, we have been involved in many different “firsts” in the U.S. dollar impact bond market. We were involved in the first U.S. dollar green bond in 2009, the first green asset-backed security, the first social bond and many more.
Each of these bonds have differing levels of impact, and each has helped us understand what might be possible through targeted, impact bonds in varying ways. At Praxis, we don’t want “perfect to be the enemy of the good” and recognize that progress comes in many forms. Rather, we believe that through product innovation, proper due diligence, increasingly high standards and robust reporting, the money and, most importantly, the impact will keep flowing.
The need for impact investments crosses many different sectors and industries, but green buildings are among the most important for several reasons. Green buildings can be developed in commercial, industrial, and residential areas and they are integral to lowering our collective energy use. According to the International Energy Agency (IEA), the “operation of buildings account for 30% of global final energy consumption and 26% of global energy related emissions.”1 Buildings are central to our lives because they encompass our homes, our workplaces, and the places where we eat and shop. Reducing the use of fossil fuels to heat and cool these buildings makes a critical contribution to our climate-challenged planet.
Understanding bonds for green building
There are four main categories where the impact — and specifically “green” — bond market intersects with green buildings. Green bonds are securities issued with a clear environmental impact focus. In some cases, the money has already been spent for the intended green purpose or the issuer has detailed specific areas where the money will be used. Three of those four green bond categories are related to residential green buildings including: multi-family housing, single-family housing, and green home improvement loans. The final green bond category is non-Agency CMBS (Commercial Mortgage-Backed Security) that have green attributes.
When it comes to the green building movement, the Praxis Impact Bond Fund purchased its first building-related green bond in late 2012. It was a $120 million bond issued by Fannie Mae on a single multifamily housing project that was LEED certified. But while supporting small individual green projects is important, institutional investors like Praxis, desire the liquidity that comes when these small projects (sometimes as small as $5 million) are pooled together into larger and more liquid deals that can reach over $1 billion. Finally, Fannie Mae issued a deal like this in 2017. It brought together 69 green loans into one pooled deal that exceeded $1 billion at issuance. This brought liquidity and — as important — attention to the green bond market. Since its inception, Fannie Mae has issued 4,700 multi-family green bonds totaling $112 billion. Today, they are one of the largest issuers of green bonds globally.
Fannie Mae issued their first single-family green MBS (Mortgage Backed-Security) in April 2020. This market took a longer time to develop because while both Fannie Mae and Freddie Mac offer green mortgage products that finance energy improvements, these didn’t really take off with lenders. Impact investors can work with issuers to bring deals quickly and in size, but we also must ensure the deals meet appropriate and meaningful environmental standards worthy of being called “green”. This is necessary to combat potential criticism of “greenwashing” or whether a particular green bond lives up to the hype. What’s most important, of course, is that these bonds contribute in a meaningful way to addressing the environmental challenges local communities, and the planet, are facing.
To address such concerns, Fannie Mae requires Energy Star® certification for new homes as a baseline for loans included in its single-family green MBS. Energy Star® certification is a global standard and Fannie Mae’s independent verifications are done by certified Home Energy Rating Companies, which helps to ensure the validity of their environmental claims. So far, there have been just $2.8 billion in single-family green bonds issued by Fannie Mae. This is a small portion of the bond market, but we are hopeful that the structural work that Fannie Mae has done will lead to a robust and growing market in the future.
Finally, I believe that the green home improvement bonds have solid market potential as well. According to the Joint Center for Housing Studies of Harvard University, there was $111 billion of energy-related improvement spending in 2021 and the overall remodeling market is $567 billion2. So far, the green bond home improvement market is still relatively small in comparison to those home improvement spending levels. The largest green bond issuance in this space comes from PACE (Property Assessed Clean Energy) securities. Praxis was involved in a deal in 2016 with Spruce ABS Trust as the issuer. It was a $84 million ABS (Asset Backed-Security) that received a single A credit rating from Kroll which is a good rating. All the loans were for home improvement projects designed to improve energy efficiency such as HVAC upgrades, electric and water improvements, and solar installations. Spruce didn’t issue another deal, but other home improvement securitizations have come to the market following this model. This seems like a ripe opportunity as the ABS market is great at securitizing small loans into larger pools which attract larger investors and drives down costs for both the issuer and the borrower.
What can we do?
Each segment of the green bond market presents exciting opportunities for real-world impact, with a lot of potential for future growth. It is important for us, as individual and institutional fixed income investors, to ask “what we can do to make a difference in the world through this part of my portfolio?” And while personal decisions like buying an electric or hybrid car, installing solar on your house, buying solar or wind generated power from your electric utility (if that is available) are great ways to make an impact, using your investment assets to make a difference is imperative too. These send their own signals to the marketplace and support the growing demand for solutions that care for the planet and vulnerable populations on it.
So don’t overlook the opportunity to invest with money managers that want to make a positive impact while also delivering solid, market-like returns to your portfolio. The problems facing our climate and vulnerable communities demand a range of responses. Investing in impact bonds and the work of the green building movement they support can be one important step most of us can take.