An investment firm takes a look at how the market for green bonds is faring in the current extremely challenging environment.
The market for “Green” bonds, a market tapping into funding of zero- or low-carbon energy projects and ventures designed to protect the environment, has grown rapidly. The global pandemic poses a big challenge to whether investors can stay the course through this crisis.
Infrastructure around such debt instruments has flourished in recent years. A new set of principles emerged in 2018 under which the Loan Market Association (the leading professional association of banks) released the green loan principles. These principles aim at creating a framework for the green loan market. They were followed in March 2019 by the sustainability loan standards.
Here are recent comments about a green bond market that now is about a decade old. The comments come from says Bram Bos, lead portfolio manager for Green Bonds at NN Investment Partners. (Seperately, this publication has been examining continued trends in the ESG space; see here for a brief overview.)
“In the current market environment, when traditional bonds sell off, green bonds sell off too. That is a fact”, Bos said. “In the last few weeks, there has not be a significant difference in how green bonds have behaved in comparison to their traditional peers.”
In markets like these, prices are not necessarily a reliable measure of underlying sentiment, he reckons. According to Bos, flows are more important; most green bond portfolios and managers are holding on to the bonds in their portfolios.
Looking at traditional corporates versus corporate green bonds, the performance of the corporates index has been slightly better. “Its composition offers a possible explanation to this,” Bos said. “The green bond corporate index does not include airlines or energy companies – those sectors were hit by the compounded effects of the coronavirus and the plummeting oil price. However, it does, for example, include utility companies that have well-regulated businesses. These tend to be better prepared for uncertain times, are more forward looking and are often better managed than firms that do not issue green bonds,” he continued.
Cyclical sectors appear to be suffering in the current environment, irrespective of whether they have issued green debt or not. But the longer-term trend is more important. In the case of the automobile industry, for example, the trend away from fossil fuel and towards renewable energy is not going to change because of this crisis. NN IP said it thinks those companies that are investing in making this transition, will have the best chance of survival in the long run. Although investors may temporarily lose sight of these aspects in the day-to-day volatility of short-term market movements, these companies are well-prepared, it said.
“In our experience, companies that issue green bonds are more forward-looking, more innovative and more flexible,” Bos said.
Spread Bloomberg Barclays MSCI Euro Green Bond Index (bps)
Source: Refinitiv Datastream, NN Investment Partners
The current volatile environment does not seem to be impacting the trend towards sustainable finance – allocations to green bonds are not being affected at all. “Although it’s still early days to draw any major conclusions”, Bos said, “we don’t see interest in green bonds diminishing in terms of our clients, nor are our funds experiencing much outflow. In general, investors seem to be pushing ahead with their plans to make new allocations to green bonds.”
Looking ahead, there are some positives that could come out of this situation, but a lot will depend on how long this crisis lasts. Markets could fall further and we could see more defaults before things get better, NN Investment Partners said.
“I think many companies will start to appreciate the qualities of green bonds as a funding tool. The traditional capital markets are suffering in these uncertain times and although green bonds fall too, the underlying demand is intact. It is all about being prepared and making your business future-proof. The next crisis could be a climate crisis. The current situation is triggering companies to look ahead.
Governments are also going to have to spend more. In particular, I believe their green expenditure will increase. They also want to make their economies more resilient. So yes, I'm very convinced there will only be more demand. We should see a continuation of the growth of the last two years and the effects of the crisis may even give the green bond market an additional boost,” he said.
NN IP expects the sovereign green bond segment to also benefit from the unprecedented fiscal and monetary policy response. This segment currently makes up about 17 per cent of the total green bond market, with fewer than ten issuers so far. Even prior to the coronavirus crisis, this was set to change with a number of new potential European sovereign candidates for 2020, including Germany, Italy, Spain, Sweden and Denmark.