It is a good moment for investors to green their bond portfolios. The asset class is considered attractive after the rise in interest rates in recent months and the increased risk premiums stemming from the Ukraine war, Johann Plé, senior fund manager fixed income at AXA Investment Managers, told InvestmentOfficer.
Bonds with a sustainable nature are popular with investors. Last year, according to Moody’s, a record amount of 1,000 billion dollars was issued worldwide in green, social and sustainable bonds (GSS) were issued worldwide.That corresponds to 11 percent of the total issue volume, compared to less than 7 percent in 2020. For this year, the rating agency expects a further increase to 1,350 billion dollars, further increasing the share of GSS bonds to 15 percent. Despite the great interest, bonds with a sustainable character are still underrepresented among institutional investors.
Mature stage
The allocation to GSS bonds remains relatively small for most, says Plé. The market is growing so fast that it will take time to increase the allocation accordingly. With an expected issue volume of 775 billion dollars, green bonds make up the lion’s share of this burgeoning market. “We believe an allocation of at least 10 percent to GSS bonds is appropriate,” said Plé.
The GSS market already exceeds the European high yield sector in size. Not only does the market now offer sufficient liquidity, the diversification possibilities have also improved greatly in recent years. “Previously, it was mainly utilities and banks that issued green bonds, but now we see that almost every sector is well represented. There is a sector-wide willingness to make the transition to a sustainable economy and companies are happy to finance this through green bonds,” he said.
The fact that governments are increasingly lending green also has a positive effect on the size of the market. “We saw new green bonds from Italy, Spain, the United Kingdom and Denmark, among others. The European Union is also active. These parties are putting large volumes into the market, further improving the liquidity of the GSS market. We expect this trend to continue, so that the green bond market eventually offers the same investment opportunities as the traditional bond market.”
Bigger Greenium
Green bond issuers usually benefit from a discount on the primary market, known as greenium. There is a lot of supply, but the demand is even greater. “The greenium reflects this imbalance, but it also indicates the scarcity of green bonds in specific sectors. We also see that it tends to rise in a risk-averse environment, acting as a buffer against generally rising spreads,” said Plé.
Recent risk aversion, exacerbated by the crisis in Ukraine, has pushed the gremium from three to above four basis points this year. This is an average. In some sectors, the premium is as high as 20 basis points, Plé said. “Investors who want to green their bond portfolio should keep a close eye on the greenium. The premium is not static but dynamic, just like the risk premiums. Overpayment is not necessary just because these bonds are green. An ETF is therefore not advisable, because investors will pay the full price.”
Sustainability-related bonds
Another fast-growing segment is the market for sustainability-linked bonds. The volume is expected to double to 200 billion dollars this year. Issuers of such bonds promise to achieve certain sustainable goals. If they do not, they have to pay investors more interest. This is interesting for companies that do not qualify for green bonds due to the nature of their activities or that are too small for this. But I would urge caution on these debt instruments, because the sustainability targets can be too unambitious and the penalty clause can be insignificant in practice.
Attractively valued
With the recently launched AXA WF ACT Dynamic Green Bond fund, Plé focuses on green bonds. Although this category is characterised by a high degree of transparency, it is not immune to greenwashing. “Therefore, we apply our own green bond framework to determine which are eligible to invest in.”
The fund aims for above-average returns in the long term by investing up to half of the portfolio in high yield bonds from, among others, emerging countries. With an active duration policy, the interest rate sensitivity can be quickly reduced if necessary.
The fund has no exposure to Russia and the energy sector, two major underperformers in the bond market this year. Still, the universe has suffered from increased risk aversion and higher capital market rates, with green bonds down more than 3 percent compared to the beginning of the year. Plé finds the valuations attractive at the moment. “The combination of higher interest rates and higher risk premiums offers a lot of value. The yield hedged in euro is almost twice as high as that on the Bloomberg Barclays Global Aggregate Bond Index.”
The growth outlook remains positive, he said. “Governments are likely to come up with support packages to mitigate the negative impact of increased commodity prices on the economy. Central banks could also be less aggressive in tightening monetary policy. It is possible that interest rates will rise further, but much has already been priced in, and risk premia should fall in the meantime. We are therefore optimistic and think that this is a good entry point.”