The $1trn market for green bonds, split between sovereign-related and credit issuers, is now more mainstream with a level of diversification that creates new return opportunities for those investors who know where to look.
In particular, the growing potential for allocating capital across the developing world may bring clear benefits for portfolio construction – in terms of risk profiles and potential yield pick-up – compared with similarly-rated European issuance, believes Axa IM.
“[This is] underpinning the case for pursuing a more dynamic strategy in green bonds – one that seeks to seize this niche-but-growing opportunity set in the market,” said Johann Plé, portfolio manager at Axa IM.
However, this requires investors to be aware that not all issuance is created equal.
Plé points to China as an example of a good warning for green bond investors. “There are risks in this market that may not be visible elsewhere,” he explained. “Is a project actually green? Does it form part of a wider corporate strategy that is positively aligned with environmental goals? How much of the funds raised could end up being used for ‘other’ purposes?”
As a result, investors should also look to promote a progressive harmonisation of global green bond standards.
A more diverse market
Such considerations have become more of a focal point as the investment potential of green bonds grows in line with the greater breadth of risk profiles on offer.
For example, while high quality issuers remain a core part of the market, high yield accounts for about 10% of the green bond universe.
More specifically, investors have seen more subordination on the credit side from banks and corporates that have issued Tier 2 and hybrid debt, added Plé.
Also notable has been the emergence of green bonds in developing markets. “China has clearly been a huge story, with estimates that issuance in 2022 could breach the $100bn mark,” said Plé.
Axa IM also sees India, Indonesia and Chile, among others, as fertile ground for investors, at both the sovereign and corporate levels.
“We firmly expect this to gather momentum over the years to come,” explained Plé. “We also think this constitutes a potential opportunity for anyone committed to an environmental strategy as it helps drive the transition in markets that may be playing catch-up, spreading financing for lower-carbon projects and companies to places where the net impact can be greater than in more developed markets.”
Keeping it green
Yet for all issuance, focusing on close analysis of each bond on its own merits is critical.
“The growth of green bonds is a healthy development… but it also opens up the prospect of companies or countries attempting to come to market with proposals that lie on (or beyond) the edge of acceptability,” added Plé.
From Axa IM’s perspective, it has seen some growth in the proportion of issuance it deems to fall short of its own internal standards.
“It’s not only true for credit issuers,” warned Plé. “We decided not to invest in more than one recent sovereign issuance as we concluded the projects earmarked to receive financing were not fossil free.”
In general, the firm has seen that those green bonds from issuers experiencing ESG-related controversies tend to suffer more than the conventional equivalent.
