Achieving net zero means global carbon neutrality, where any greenhouse gases emitted are cancelled out by those removed with new technologies and new habits. It requires a major shift in how investors allocate capital, and how they engage with companies to turn well-meaning ideas into action.
Today we're going to explore one option that investors have to start their own climate transition. This involves mobilising some of the $125trn accumulated in the global bond market.1 That's a lot of money - and a lot of potential climate impact stored up, ready to deploy.
We're talking about ‘green bonds', a relatively new but booming segment of the bond market. Green bonds offer investors a way to direct some of their capital towards climate projects. The rationale for including them in portfolios is stronger than ever.
Investing with purpose
When you buy a normal or ‘vanilla' bond, you're lending your money to the issuing company or government with no strings attached. The issuer uses the proceeds for an unspecified purpose, and pays a coupon on the bond in return. Eventually - in most cases - you get your principal (loan) back.
Green bonds, in contrast, raise money for a specified purpose. For a bond to be certified as green, its proceeds must help fund climate or environmental projects. So, unlike with a vanilla bond, you will always know where your money is going. You can think of it as financing with ‘green strings attached'.
A green bond could be financing a new windfarm, or a project to increase a low-lying town's flood resilience, or a train station refurbishment which boosts public transport use - any of a wealth of projects that will go on to benefit the environment in a specific, tangible way.
Put simply, green bonds offer much more transparency and measurability than normal bonds. Yet they still fly under the radar for many investors. Many, that is, but not all. Away from the mainstream, the green bond market has been booming in popularity.
Why green bonds are going mainstream
Speak to any climate activist and you'll hear the fight against climate change is slow - too slow. One reason why is because climate projects need to be financed, and there hasn't been a good mechanism for connecting investor cash with the green projects that need it most.
Let's consider for a moment what climate-action or mitigation projects involve. This could be capital expenditure for new infrastructure, or major changes to existing systems, or investment in developing technologies. It all costs money, and sometimes that money is hard to find.
But it's not an act of charity - these are investments, and so they come with a return. Just like their vanilla counterparts, green bonds pay a coupon. After all, a windfarm will generate and sell electricity. A new transport hub will process thousands of paying passengers. Flood resilience is worth paying for today if it reduces future costs. Investing in the energy transition is still investing.
That's why, even putting environmental concerns aside, green bonds can be an attractive investment. They offer returns and diversify portfolio risk while contributing to climate action in a measurable way. And they are being rapidly snapped up by investors waking up to the fact that environmental benefits don't have to come at a premium.
Investors are waking up to the potential
Green bonds are still a small part of the giant global bond market, but they're on a very strong growth trajectory. The left-hand chart below shows cumulative labelled green bond issuance globally. This crossed the $1.5trn threshold in 2021, having hit $1trn as recently as 2020.
The right-hand chart shows cumulative flows into green bond ETFs domiciled in Europe. We can see a similar shape emerge, one which has been referred to as exponential growth by Climate Bonds Initiative, an organisation mobilising capital for climate action.
The issuer mix for green bonds (the proportion of green bond issuers that are corporate, sovereign, local government, etc.) is very different from the overall bond market. Just 13% of total issuance is from sovereign issuers - national governments - versus 59% in the global bond market. The reverse is true for corporate issuance: 49% of green bonds are issued by corporations, versus 19.5% in the global bond market.
We believe sovereign green bond issuance will rise further, bringing the issuer mix closer to what we see in the global bond market and increasing the size and diversity of the bonds on offer to investors. More national governments have been testing the market, including 2021's new entrants, the UK and Sweden. The UK issued its first green Gilts of £10bn and £6bn, becoming the largest issuer of 2021 and catapulting itself straight into the top 10 issuers by amount outstanding.
With energy independence and security rapidly climbing the governmental agenda, even more may decide to issue green bonds to finance the transition, rather than rely on external fuel sources or less direct funding. That could create an interesting evolution of the market and offer new opportunities for fixed income investors.
Make an impact with a green bond ETF
Green bonds provide a route forward to shift trillions into projects where they will make the most difference.
Of course, for most people it's not practical to buy and sell individual green bonds. That's why green bond ETFs bring together labelled green bonds and provide them for investment in a simple ETF wrapper. The Lyxor Green Bond (DR) UCITS ETF is the original, and still by far the largest with €557 million under management2.
We strongly believe green bonds are a crucial part of the climate transition. That's why we offer several options for adding green bonds to a portfolio, including our industry-leading aggregate bond ETF, eurozone government green bond, and our corporate green bond ETF.
1.SIFMA Research Quarterly: Fixed Income - Issuance and Trading, January 2022. https://www.sifma.org/resources/research/research-quarterly-fixed-income-issuance-and-trading/
2.Source: Amundi, AUM at 30/05/2022. As of 01/01/2022, Lyxor ETF is part of Amundi Asset Management.
This post is funded by Amundi ETF
CAPITAL AT RISK
For complete information on risks in relation to an investment in one of Amundi's green bond ETFs, please refer to the dedicated "risks warning" section of the prospectus and to the Key Investor Information Document ("KIID") both available on our websites www.amundietf.com or www.lyxoretf.com. It is important for potential investors to evaluate the risks described in the KIID and prospectus of the green bond ETF before making an investment.
Please note: The approach implemented by Amundi's green bond ETFs by investing in green bonds is largely based on third party data that may be incomplete, inaccurate or unavailable from time to time, and which make it dependent on the quality and reliability of such information. Investment in green bonds may also induce sectoral biases in the global bond market. For more information, please refer to the prospectus of the fund.
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