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Green Bonds: Market Growth Continues

April 18, 2023

Read Time 4 MIN

Green bond sales just hit an all-time record, reflecting continued demand for sustainable fixed income within a core bond portfolio.

Sustainable fixed income investments, and green bonds in particular, have fared relatively well over the year amid a less favorable environment for other areas of the sustainable finance market. U.S. mutual funds and ETFs that incorporate environmental, social and governance (ESG) factors into their investment strategies suffered their first calendar year net outflow in 2022 since 2016.1 Most of these funds are underweight or avoid traditional energy sector names altogether, hurting performance given that sector’s outperformance. Further, many ESG equity strategies tend to be more growth-oriented, which generally suffered in 2022. Aside from performance, it is also undeniable that sentiment towards ESG investing has had to withstand greater scrutiny on “greenwashing” as well as increasing politicization.

A Relative Bright Spot Within Fixed Income

Unlike equity strategies, fixed income ESG flows were modestly positive for the year, although much lower than 2021’s record. In the primary markets, green bonds experienced their busiest quarter ever in terms of new issues, according to Bloomberg, with approximately $164 billion of new issuance representing a 32% year-on-year increase. Many corporate and governmental issuers rushed to market to take advantage of favorable conditions, including continued high demand for sustainable fixed income investments – particularly those featuring the green “use of proceeds” structure that defines green bonds.

We believe that the structure of green bonds has made them relatively more resilient to some of the complexities and criticisms of other ESG strategies. This is all the more notable, in our opinion, given the significant volatility in bond markets since the beginning of 2022. Because they only finance environmentally friendly projects, the evaluation of green bonds is more objective and straightforward versus a broader assessment of an issuer’s sustainability credentials.

Avoiding Greenwashing

Not every “green” project is unambiguously green, but projects being financed can be assessed against a taxonomy such as the one maintained by the Climate Bonds Initiative (“CBI”) to determine whether they are consistent with a low carbon economy and the goals of the Paris Agreement. The CBI has long been a leading voice in the sustainable fixed income market, and their taxonomy is based on climate science and informed by technical experts, as well as ongoing dialog with market participants. In addition, we have observed a notable improvement in the level of disclosure provided by issuers in terms of both the level of detail provided on the projects financed, as well as an increase in the number of issuers providing estimated environmental impact figures (e.g. greenhouse gas avoided). Although more work is needed to enhance and standardize disclosures market-wide, we believe this is a positive development that helps to allay concerns about greenwashing and is another factor that has provided support to the green bond market’s continued growth.

Developments in the Green Bond Market

The resilience of the green bond market has supported some exciting developments. For example, several new issuers have come to market in the past year while repeat issuers continue to report a positive experience in the market. For example, according to CBI research, numerous repeat issuers emphasized that the green label has supported deal placement, even in the volatile market conditions experienced over the past year. Ireland’s sovereign issuance was ten times oversubscribed, for example. India came to market in the first quarter with its first sovereign deal, bringing the number of sovereign green bond issuers to 31. Household U.S. companies like General Motors, Ford, PepsiCo and Comcast have issued USD-denominated green bonds since the start of 2022.

From a return perspective, green bonds continue to perform as expected – that is, in line with traditional non-green bonds because the risk and return profile of a green bond is generally the same as a non-green bond, all else equal. As shown in the chart below, performance has been highly correlated to a broad aggregate bond exposure, with differences primarily explained by sector differences. In a year such as 2022, that meant similarly dismal performance as other fixed income asset classes. However, longer-term we believe this provides a strong case for including green bonds within a core bond portfolio, especially at today’s higher yields. From a yield, duration and quality perspective, an allocation to USD-denominated green bonds does not have a major impact on overall risk and return. At the same time, investors may benefit from more diversified sector exposure and a tilt towards issuers who are proactively addressing sustainability in their operating plans and strategies.

Performance of Green Bonds vs. Broad Aggregate Bond Exposure

Performance of Green Bonds vs. Broad Aggregate Bond Exposure

Source: Morningstar. USD Green Bonds is represented by the S&P Green Bond USD Select Index; US Agg is represented by the ICE BofA US Broad Market Index; US IG Corporates is represented by the ICE BofA US Corporate Index.

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DISCLOSURES

1 Source: Morningstar, as of 4/10/2023.

Please note that VanEck may offer investments products that invest in the asset class(es) or industries included herein.

This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck. Past performance is no guarantee of future results.

Sustainable Investing Considerations: Sustainable investing strategies aim to consider and in some instances integrate the analysis of environmental, social and governance (ESG) factors into the investment process and portfolio. Strategies across geographies and styles approach ESG analysis and incorporate the findings in a variety of ways. Incorporating ESG factors or Sustainable Investing considerations may inhibit the portfolio manager’s ability to participate in certain investment opportunities that otherwise would be consistent with its investment objective and other principal investment strategies.

Investing in “green” bonds carries the risk that, under certain market conditions, the Fund may underperform as compared to funds that invest in a broader range of investments. Investing primarily in “green” investments may affect the Fund’s exposure to certain sectors or types of investments and will impact the Fund’s relative investment performance depending on whether such sectors or investments are in or out of favor in the market. The “green” sector may also have challenges such as a limited number of issuers, limited liquidity in the market and limited supply of bonds that merit “green” status, each of which may adversely affect the Fund.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.

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