Green bonds have a lot to gain amid low supply and high demand
Fixed Income Strategist
Summary: This year, green bond supply has slowed down amid the coronavirus pandemic, making these instruments rare and sought after real money. At the same time, the ECB will start to accept these securities as collateral from 2021, contributing to higher demand. There are several advantages in investing in green bonds: low volatility, stable returns and the possibility to backed by a reputable entity.
Green bonds are instruments aimed at raising money for climate and environment projects. The issuing entity's balance sheet backs them up; therefore, they carry the same credit rating as their issuer's other bonds.
Green bonds have become the most discussed topic in 2020. It is not a subject confined only to Joe Biden's election campaign; this is a topic that governments worldwide have been embracing and starting to act on it. If you want to learn more about this topic in relation to what is happening in Europe, with the ECB accepting sustainability-linked bonds as collateral starting from next year, please refer to my colleague Christopher Dembik's latest article.
Different types of green bonds.
Green bonds can be issued by several entities such as banks, corporates or governments.
Green bond supply in the sovereign space is quite limited, and so far we have seen only five European countries issuing these instruments: Germany, France, Netherland, Belgium and Ireland. Germany's first green bond issuance earlier this month, was well received by the market with order books reaching $33bn in demand. The deal (DE0001030708) priced one basis point below the DBR benchmark's yield, sending the signal to other European countries that they might be able to issue green debt cheaper than their current yield curve.
This bond issuance was a remarkable event for several reasons. Firstly, it was “twinned” with an equivalent conventional bond in order to test the existence of the “greenium” (the extra spread an investor would require to buy a green bond) and to guarantee liquidity to green assets compared to conventional instruments. Secondly, it provides a risk-free benchmark to the European green bonds world, which wasn’t existing before. Germany's ambition is the one to issue more green bonds in order to create and European green yield curve.
While discussions concerning green sovereigns are relatively new, the European corporate space has been active in issuing green bonds since the European Investment Bank launched the idea in 2007. According to Bloomberg data, there is €223bn worth of euro-denominated corporate green bond debt outstanding. They offer an average yield of 3.4% and maturities till 3020 (no it is not a typo, although callable, we are still talking about maturities 1000 years from now).
This month we have seen Volkswagen issuing green bonds with 8, 10 and 12 years maturity in a bid to finance electromobility projects to ramp up its electric-vehicle production to overtake Tesla. The company was able to raise funding much cheaper than its corporate yield curve with the eight-year tranche 15 basis points tighter and the twelve-year bonds 13.5 basis points tighter. The demand for these bonds was extremely high, order books reached €11bn, and the company issued only €2bn worth of notes.
We expect to see more of these issuances as issuers are attracted to cheap funding, and the ECB starts to accept green bonds as collateral.
What is driving green bonds performance?
The main driver of green bonds' performance is demand. At the moment, there is a limited amount of green bonds available; however, as Christopher explained, real money has to invest in these instruments to meet fiduciary duty requirements. The amount of institutional investors with the mandate to invest in ESG projects has been growing steadily while green bonds issuance has slowed down amid the coronavirus pandemic. At the beginning of the year, Moody’s had estimated around $400bn of new green bond issuances, a few months ago it had to revise this figure down to $225bn. Hence, a considerable number of institutional investors are flocking into ESG deals pushing prices higher.
Why choosing green bonds over environmental and sustainability stocks or ETFs?
Even though green bonds look expensive, they are less speculative and volatile instruments compared to stocks and provide stable cash flows. At the same time, one gains exposure to ESG projects, which ultimately means being less exposed to fines and disinvestment risk. The main reason why green bonds are more interesting than stocks and ETFs is that you can pick an issuer which core activity doesn't have anything to do with ESG. As we mentioned above green bonds can be issued by several entities such as governments, banks, or corporates. Hence, one will have exposure to ESG, but the investment will be backed by a stable company which one already knows without getting risk to be involved in unknown names.
We believe that this is a great moment to gain exposure in green bonds as we expect spreads to tighten as supply doesn’t match the instrument’s demand.
Where can I find green bonds on the Saxo platform?
You Can trade green bonds online with Saxo Bank, and you can find a list of securities here. You can also gain exposure to these instruments by trading the following UCITs: Lyxor Green Bond (DR) UCITS ETF (KLMH:xetr; CLIM:xmil)