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Expert Opinions

Why green bonds make sense for investors

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François Millet, Head of ETF Strategy, ESG and Innovation, and Philippe Baché, Head of Fixed Income ETFs at Lyxor, discuss the key features and drivers of the green bonds market and examine their diversification benefits in a fixed income portfolio.

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Why green bonds make sense for investors
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How do green bonds help investors support climate-friendly projects?  

Green bonds were specifically created to fund projects that have positive environmental and/or climate benefits. Proceeds are earmarked for green projects but are backed by the issuer’s entire balance sheet. They are especially attractive to the growing number of investors looking for high-performing green assets, policymakers who need to align policy with the Paris Agreement goals, and companies looking to transform their operational and product models to achieve carbon emission targets. Europe is currently the largest issuer of green bonds, followed by the USA, and Asia-Pacific. In Europe, France leads by a long way, followed by Germany and the Netherlands. A good example of a Green Bond issuer is the Société du Grand Paris (SGP), which is among the largest green bond issuers in France. The SGP was established in 2010 by the French Government to construct the Grand Paris Express, which expands the Parisian metro and rail transport network, which being all-electric and with high passenger capacity is fully compliant with the CBI’s strict low-carbon transport criteria. Since its entry into the green bond market in 2018, SGP has raised €16 billion.  

How have green bonds weathered the market turbulence in 2020? 

Despite the Covid-19 crisis, 2020 could set a record year for Green Bonds issuance. The CBI reports average monthly issuances close to $20bn to September. In the first half of 2020, the overall number of green bond issuers passed the 1,000 milestone, reaching 1,056. Sub-sovereign issuers represented the lion’s share of total issuance, mostly from government-backed entities. So far in 2020, most of the proceeds of green bonds were invested in energy, transport and buildings. Other eligible uses of proceeds are water, waste, land use and marine resources, industry, and information & communications technology (ICT).   

Why are green bonds a valuable asset to an investment portfolio? 

While the green bond market is still small, representing 3.7% of current total bond issuance and less than 1% of the global bond market, its fundamental drivers are stronger than ever, which is why investors are allocating ever more funds to green investments. The CBI’s analysis suggests that most green bonds tend to be issued with a yield level higher or equivalent to conventional bonds, and that, on average, spread compression post-issuance tends to be higher for green bonds than for ordinary bonds. Because of this, and because green bonds help issuers on their climate transition towards a lower carbon footprint, a debate has grown around a potential “greenium”, and whether investors should be ready to pay a higher price for a green bond. A “greenium” would materialise when a green bond is issued with a higher price (and corresponding lower yield) than conventional bonds at a specific point in time. Finally, in a world where environmental risk considerations are increasingly focusing minds, including green bonds in a fixed income portfolio allocation provides a hedge against climate-related risks, versus a more traditional bond portfolio allocation. This gives investors a much-needed source of diversification to portfolios. Beyond the non-financial interests of investors, the case for green bonds begins with the rationale for holding any fixed income investment in a portfolio: income and risk levels compared to other portfolio holdings.