No guilt about avoiding green gilts

21 October 2021

My wife is a radiographer for the NHS, meaning her salary is paid from all of our taxes – and for your contribution to the Overend family income, I thank you. Yet my feelings of gratitude would fade fast if you were to stipulate that HMRC could only use your tax to fund green projects. I, for one, would not want to live in a country where newly-planted forests and wind turbines decorated our countryside, while rubbish piled high in our cities’ streets, inmates ran amok in prisons and my wife went unpaid.

While imposing restrictions on the use of the tax we pay might seem far-fetched, this is precisely what is starting to happen with money loaned to the Government.

The tax received by the UK Government does not fully cover its expenditure, so the Government borrows the shortfall. This is achieved through the gilt market – a gilt effectively representing an IOU from the Government, which promises to pay an investor back their loan at a future date with a small amount of interest paid in the meantime.

The emergence of green government bonds in the UK

Until now, money raised from the sale of gilts went into the Government’s coffers along with our tax payments, and the entire pot was used to cover all government expenditure. The recent issuance of the UK’s first green government bonds changes that dynamic –we now have a hypothecated pool of money (£10bn from the first issuance last month) that is to be spent exclusively on green projects. These include zero-emission buses, offshore wind farms and schemes to decarbonise homes.

Each of us will have our own views on how governments should spend their money. Not everyone will welcome defence spending, for instance, and the foreign aid budget clearly divides opinion, but we have a process for regulating this. Prospective governments prepare a manifesto and the public makes its choice every five years or so. It might not be a perfect system, but it surely has to be better than governments spending money only on projects for which they can raise capital.

Furthermore, it’s worth noting that one school of thought suggests that green government bonds are unnecessary as much, if not all, of this eco-expenditure would have happened anyway.

From the Government’s perspective, however, the issuance of green gilts at the current time is a masterstroke. So great is the clamour for green investments that high demand at the recent green gilt auction resulted in a lower interest rate being paid by the Government than would have been the case if the money had been raised through the sale of traditional gilts.

The Government intends to continue issuing green gilts and, while I have some reservations about the merits of hypothecated borrowing, I welcome the new approach if it genuinely means that there will be an increase in funding for green projects.

It’s worth asking, however, whether green gilts make as much sense for pension scheme trustees.

Should scheme trustees invest in green government bonds?

As investors, trustees might use ESG criteria to shun certain investments. A decision to invest in the shares of a solar panel manufacturer rather than those of an oil company might be perfectly understandable, even if the latter offered higher expected returns.

However, I do not think a consideration of that nature is meaningful when it comes to gilts. Why be so blinkered as to only invest in green gilts when the money raised from traditional gilts is also used to sustain our green and pleasant land? If, as at present, the ‘pleasant gilts’ offer a higher expected return than their green counterparts, then surely the former should be preferred by trustees wishing to hedge liabilities?

Let’s look at two potential reasons for schemes to invest in green gilts:

1. Trustees might wish to allocate part of their scheme’s assets to green projects. Buying green gilts would clearly achieve that – but, with an expected return of just 0.9% per annum, it hardly represents a compelling investment proposition.
2. Green gilts could be used to hedge the scheme’s liabilities. For this purpose, the yield on the gilt is less important – what matters is ensuring that the value of the investment moves in the same way as the liability value when interest rates fluctuate. In such a situation, I remain unconvinced that trustees should be unduly concerned as to whether the gilt is green.

Ultimately, how important is it whether the money a pension scheme lends to the government is used to build a wind farm, to provide free school meals, or to support businesses struggling to cope with a global pandemic?

If you read over the coming months that other pension schemes are starting to invest in green gilts, my advice to you would be to not go green with envy.

The views and opinions expressed in this article are those of the author, and do not necessarily reflect the official policy or position of First Actuarial.