Capital allocation in financial markets serves as a proxy for societal values – a representation of the goals we wish to accomplish with the tools available at our disposal.
A little over a week ago, we wrote about a rising trend in capital markets: ESG investing. Guided by the desire to achieve positive environmental impact, or at least counterbalance the negative impact caused by industrial externalities, ESG ETFs have seen massive capital inflows.
With ESG principles imbuing the zeitgeist of the investment world, bond markets are now responding – with green bonds. Sustainability has added a new dimension to fixed income investing, and investors are increasingly looking to become creditors to ESG-friendly ventures.
Simply put, green bonds refer to a broad range of fixed income instruments that are tied to projects that create an environmental benefit. The trend started in 2007, with the European Investment Bank issuing its first “climate awareness bond”.
Today, the value of green bond issuances has grown from less than $20 billion in 2013 to more than $200 billion in 2019. The green bond market is relatively small, representing only 2% of total bond issuances in the past two years. However, volumes continue to grow, particularly in Europe and Asia as demand for such financial instruments becomes popular.
Recently, the proceeds from such bond issuances have been used to fund endeavors including renewable energy, public transportation, waste management, and agricultural ventures.
In particular, green bonds offer investors some unique advantages when compared to other fixed-income instruments. There is greater investor and regulatory oversight, technical support for prices (derived from a higher level of demand than supply), and of course, the positive environmental impact resulting from the investments.
The rise of ESG investing has also led to the creation of other fixed-income offerings such as social bonds, green loans, or sustainability bonds. The lack of consistent taxonomy and reporting standards have allowed other kinds of investments to be bracketed into similar categories, even though they might be targeted towards a different portfolio of impact (such as social justice).
When it comes to performance, green bonds have generated similar returns when compared to regular fixed income instruments on a risk-adjusted basis.
So far, 180 nations have ratified the Paris Agreement, and developmental economists have begun to focus on sustainability as reflected in the UN Sustainable Development Goals. By 2030, this asset class could be allocating nearly $7 trillion a year.