Time is running out to meet the global goal of reaching carbon neutrality and limiting global warming to 1.5⁰C. As governments, businesses and consumers grapple with different ways to accelerate the environmental and energy transition, it’s becoming increasingly clear that everyone has a role to play – including fixed income investors.
Green bonds have emerged as a credible and measurable fixed income solution for helping to finance a radical transformation of the energy mix. The openness to engagement, free dialogue and sharing of best practice makes the green bond market one that governments and policy makers worldwide are keen to promote.
In 2022, the brutal macroeconomic headwinds that challenged global bond issuance across the board also saw green bond volumes fall year-on-year for the first time in a decade.1 Bertrand Rocher and Agathe Foussardfrom Mirova explain why 2023 looks brighter for the sustainable fixed income landscape.
BERTRAND ROCHER: First, it’s a way to differentiate one’s bond portfolio. The diversification of the green bond market is catching up with traditional bonds, and they can achieve comparable, and sometimes better, financial performance too. Even if the investor is not that interested in ESG factors, it can be an interesting investment for clients in terms of diversification and performance.
Second, there are the strong, positive ESG considerations. Green bonds are a great way for investors to have transparency over their portfolio, so they can see how their money is invested from an ESG impact perspective.
Moreover, green bonds offer an efficient way to reduce the carbon footprint of a portfolio. Therefore, if you have clients who are still at the initial stages of trying to adapt to ESG investing, it’s the simplest and most direct way of showing them that you’re committed to investing in this area of the market.
AGATHE FOUSSARD: Last year aside, the market is growing. The slowdown in 2022 was not specific to the green bond market either – rising rates meant there was a slowdown in total issuance, not just of green bonds but across conventional bonds too.
We expect the markets to expand this year and we hope to have more visibility for fixed income markets and bond issuers generally. We think issuers will come back to the market, perhaps with around $900 billion of new issuance. We expect to see expansion in the green and sustainable bond frameworks, although perhaps a lower momentum with social bonds.
BR: Given that inflation is now seemingly plateauing, and that it will probably rebound a little bit over the coming months before it recedes – as will rates – the longer duration of green bonds might benefit them. Fundamentally, green bonds are likely to outperform because the rest of the market generally retains a shorter duration.
AF: Also, note that this duration gap has narrowed over 2022, making green bonds less sensitive. It's pure maths really. So, with higher yields, bonds have turned less sensitive to market moves and we now have lower duration for the global green bond index, for example. Furthermore, we saw more issuances on the shorter end of the curve.
In recent years, it has just been more attractive for issuers to finance themselves in the long end of the curve, as yields were very low. Now it's different. So, we expect there to be more and more issuances in short- to medium-parts of the curve.
Actually, we’ve already seen many issuances below five years.2 But we also need to accelerate the environmental transition. The horizon is getting shorter, so we expect to have issuers that will need to finance themselves in the short term.
Overall, the green bond index has had a longer duration compared with conventional ones – this bias is being reduced, given this new trend of shorter maturity for primary issuances.
AF: It’s largely due to these asset classes’ differences from the Euro aggregate or global aggregate indices, and that the projects financed through green bonds tend to have a longer-term horizon.
We have many supranationals, agencies, and more and more sovereigns that issue green bonds. They issue in the long term part of the curve compared to the conventional aggregate index, which has issuance from sovereigns at every point of the curve, which means the green bond index tends to have higher duration.
It’s also a recent market. So, the average maturity of the bonds that have been issued 35 years ago is longer than the bonds on the rest of the market, which may have been issued just 10 years ago.
BR: According to our definition of what constitutes a green bond, there are some states that have issued green bonds that would simply not fit our criteria here at Mirova.
To take just one example, we are still monitoring the quality of the German green bond – specifically how Germany is getting access to energy from coal. Our feeling is that it might demonstrate that the overall strategy of the German state is not aligned with the strategy it is pursuing with its green bond.
And in this particular case, it might mean that further down the line we will have to reconsider whether Germany's green bond is still green.
BR: Well, green bond issuers have to commit to reporting, so usually they report at least once year. They report on the kinds of projects being invested in, so if it's a renewable energy project they also provide the megawatts capacity of these projects. If it's energy efficiency, then they also try to provide the energy efficiency gains.
They often report their own carbon emissions too. However, this is an area in which we pay particular scrutiny. We look more closely at the invested project and use our partner, Carbon 4 Finance, to calculate the carbon emissions.
This creates a direct link to projects which, when combined with the subsequent reporting and the increased transparency that we see in the green bond market, makes it is easier for us to report on the impact for our fixed income funds – indeed, much easier than it is to report on impact for other asset classes.
Fundamentally, we pay close attention to the level of detail and transparency of the impact reporting provided for every project we consider.
BR: We’re now seeing institutional clients from the UK, Asia, Ireland, Spain and Italy getting more interested in enjoying more transparency for their investments, and therefore allocating capital towards a low-carbon economy. It’s further instruction that there’s a growing interest in investments that will preserve prosperity. And it is very exciting to feel that people understand what it's about, that it helps you diversify your portfolio, manage your risk framework, and deliver impact.
And that’s largely because the green bond market has matured. People had heard about them five years ago, but they just assumed it was a niche investment. French guys with funny beards – that sort of thing. Now they understand it can perform well, that it’s a financial product on a platform that can deliver impact. It's something real, tangible. And it can add real value to client portfolios.
2 Source: Bloomberg NEF (in 2022, primary issuances with a maturity of less than 5 years accounted for 12% of the total amount issued, versus 6% in 2019)
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