Improved returns make green bonds increasingly worth banking on

Estimates vary, but there is broad agreement that more than $1 trillion (€930 billion) worth of green bonds were issued during 2022 and that cumulative issuance has now reached more than $2.5 trillion. And, according to Aviva Investors investment director Peter Smith, green, social, and sustainability-linked bonds accounted for 5 per cent of the global bond market in 2022.

But what exactly are green bonds and why should anyone invest in them? The simple answer is that they are pretty much the same as a standard bond and people should invest in them for the same reasons, with the bonus of being able to add green objectives to their portfolio.

“A green bond works exactly like a regular bond with one key difference,” explains Deloitte sustainable finance lead Marc Aboud. “The money raised from investors is used exclusively to fund investments with positive environmental impact such as renewable-energy projects and green buildings. The use of proceeds is the key differentiator.”

Aboud points out that green bonds are relatively new in investment terms. “The first green bonds were issued in 2007 and the market grew quite slowly in the first 10 years. It really started to take off after COP21 in Paris in 2015 and the formulation of the UN Sustainable Development Goals the same year. The Green Bond Principles were developed in 2014. This is a framework that many issuers align with.”

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John Thornton, executive manager, fixed income, at Irish Life Investment Managers, points out that there is no official regulation designating exactly what is a green bond yet. “As a result, some green bonds are independently verified by bodies like the Climate Bond Initiative, Sustainalytics or MSCI while others are self-certified by the issuing company,” he notes. “Clearly, self-certification isn’t ideal and could open investors up to accusations of greenwashing. So, from an investor perspective the classification is a developing area. We expect the EU to issue formal guidance on what explicitly qualifies as a green bond later this year.”

In fact, EU negotiators have announced agreement on the first best-in-class standard for green bonds. The European Green Bonds Standard (EUGBS), which companies issuing a bond can choose to comply with, will give issuers more certainty that their bond will be suitable to investors seeking green bonds in their portfolio. It will enable investors to identify high-quality green bonds and companies, thereby reducing greenwashing.

That clarity is critically important as the main attraction of the bonds for many investors tend to be their green characteristics. “Green Bonds offer investors a clear understanding of the impact of their investment,” says Michael Curran, head of institutional business at Amundi Ireland. “For example, bonds targeted to financing the energy transition report on the tons of avoided CO2 emissions, making the impact more tangible for investors. The increased integration of sustainability targets and net-zero ambitions across investment portfolios means that green bonds can be an important component of a portfolio’s bond allocation and its returns, whilst also keeping that green stamp of approval.”

This ‘greenium’ has reduced across 2022 and now is close to zero. Investors can now allocate their capital to green bonds without effectively sacrificing return

—  John Thornton

The attractiveness of the green bond market is evidenced by the issuance of €77 billion in new bonds in the first two months of 2023 alone, Curran adds. “This, accompanied by an ever-increasing social, sustainable and sustainability-linked debt market means there are several attractive places for investors to park their responsible euros,” he says.

On the other hand, investors have to be aware of something known as the ‘greenium’. Investors in bonds get returns in two ways; the first is through the repayment of the original investment at the end of the term of the bond, the second is through a fixed-interest payment, normally payable twice a year, known as the coupon. However, because green bonds have tended to be priced higher than normal bonds, this has the effect of reducing the value of that coupon.

But that is beginning to change, according to Thornton. “For the last number of years, investors would get marginally lower returns by investing in green bonds. This greenium has reduced across 2022 and now is close to zero. Investors can now allocate their capital to green bonds without effectively sacrificing return. All the other features of bonds are broadly the same.”