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ESG

Municipal Bonds Can Naturally Meet ESG Goals

Eve Lando, JD

Portfolio Manager and Managing Director

Dominic Alto

Client Portfolio Manager

13 Jan 2020

3 min read

Exploring the diverse ways in which municipal bonds can meet the growing investor interest in ESG.

Q. What asset class naturally offers ESG investment opportunities, relatively low risk, public market liquidity, tax benefits and a better return than U.S. Treasuries?

Hint: The first of its kind was issued in 1812. Find the answer below.

ESG investing, also known as sustainable investing, is becoming increasingly important in the marketplace. This investment approach combines environmental, social and governance criteria with financial metrics. Investing according to ESG principles doesn’t have to mean giving up returns and can often reduce risk. That matters, given the increasing investor interest.

A 2019 survey in the U.S. found that more than 85% of individual investors and 95% of Millennials (the population group born 1981–1996) expressed interest in sustainable investing. These percentages were each up about 10% over the 2015 poll results. In addition, the 2019 survey found 65% of respondents wanted more sustainable investment product choices.¹ For these ESG investors, municipal bonds can represent a core holding.

Municipal Bonds and ESG Investors Seem Made for Each Other

Muni bonds are a natural asset class for ESG investors for several reasons:

Munis often finance projects devoted to health care, education, environmental enhancements and infrastructure facilities intended to improve communities and the lives in them.
The social and environmental outcomes from muni bond financings are often measurable and material, a win for many ESG investors seeking impact.
Munis can benefit taxpayers through tax exemptions and governments through reduced financing costs.

“Green” muni bonds² typically raise funds for renewable power, clean water, waste management and energy-efficiency projects, including buildings, but they represent only about 2% of all muni issuance. While most muni bonds are not officially designated “green,” many are issued with intended outcomes that align with ESG principles. In fact, most muni bond issue proceeds are used to finance social and environmental needs.

Use of Proceeds from Municipal Bonds (Issued 2009–2018)

Sources: MSRB, Thomson Reuters, 2018

Challenges of Integrating ESG Research with Financial Analysis

Integrating ESG research with rigorous financial analysis can help limit performance risk, but there is a lot to scrutinize. Considerations include planned use of the muni bond issue proceeds, project location, climate change impact and the sustainability of the project.

Moreover, with 50 states and many municipalities issuing bonds under different laws and statutes—all potentially influencing investment outcomes—muni bond analysis can be complex. Risks and opportunities can differ by issue as well as issuer, state and municipality. A due diligence checklist can help ensure that investors get the ESG outcomes they seek.

Indispensable Role of the Municipal Bond Portfolio Manager in ESG Analysis

Rating agencies are only beginning to consider ESG criteria in their evaluations, but some portfolio managers of muni bond funds have been actively factoring in ESG analysis for many years. Depending on investors’ specific ESG concerns, active portfolio managers can offer customized muni SMAs with exposure to mission-driven themes, such as faith-based, mental health or carbon mitigation.

Sustainable investing can be a powerful tool for change. Municipal bonds, by their very nature, should play a major role in ESG investment portfolios. However, as universal ESG rating standards are not available in this asset class, investors may choose to rely on the expertise of proven muni bond portfolio managers to find the best opportunities.

Answer: Municipal bonds.³The first recorded municipal bond was a general obligation bond issued by the City of New York for a canal in 1812.

1. Source: “Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice” research by the Morgan Stanley Institute for Sustainable Investing. Population grouping from Pew Research.

2. Source: International Capital Market Association, The Green Bond Principles 2018 and Climate Bonds Initiative

3. Source: Thornburg analysis and MSRB muni fact sheet

Important Information

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

This is not a solicitation or offer for any product or service. Nor is it a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Thornburg makes no representations as to the completeness or accuracy of such information and has no obligation to provide updates or changes. Thornburg does not accept any responsibility and cannot be held liable for any person's use of or reliance on the information and opinions contained herein.

Investments carry risks, including possible loss of principal.

Please see our glossary for a definition of terms.

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