The euphoria surrounding the early years of what was then a new and promising asset class has now faded. We revisit the hurdles that have since emerged to investing in green bonds as an asset class and highlight how rethinking Green bond portfolio construction can help unlock the full potential we believe this asset class offers.
Looking Back
The early days: from strength to strength
The 2015 Paris Agreement on climate change was a catalyst for rapid expansion of the green bond market. Consequently, issuance volume doubled every year, consistently surpassing previous records.
By 2021, the green bond market had become less concentrated and more liquid. Not only had it reached a critical size, depth, and granularity, it had garnered strong investor appetite by offering transparency and impact measurability – all at a time when bond yields were close to zero.
Reality check
Enter the rates shock of 2022, in which rapidly rising interest rates severely impacted bond markets, hitting duration heavy portfolios even harder. Coupled with acute credit spread widening, it was the perfect storm to shake up traditional benchmarked green bond strategies.
This may have resulted in something of a wake-up call for sustainability investors as focus around impact credibility gave way to greater scrutiny around performance. This did not help to dissipate the misconceptions that investing in Environmental, Social, and Governance (ESG) strategies might imply sacrificing financial returns. The subsequent underperformance of sustainable equity strategies versus large technology stocks certainly failed to shake this narrative as well.
A new chapter
One cannot ignore that the sentiment around ESG investing seems to have shifted since the early days – ESG fatigue appears to have set in no doubt influenced by regulatory burdens, reporting complexity, and backlash in the US. Meanwhile, flows into SFDR Article 9 funds have declined in recent years.1
Yet if we fail to look beyond the surface, are we missing out on a prime opportunity at a time when diversified Fixed Income has become increasingly attractive?
[1] Morningstar – How SFDR 2.0 Could Reshape ESG Fund Flows.
