Sustainable bonds (the collective term for green, social and sustainability bonds) is a growing asset class that has become a by-word for impact investing in a fixed income portfolio. As interest in this asset class continues to increase, so does the need for understanding the nuances behind them.
Here we share a few of the questions we are being asked about green bonds:
1. Do green bonds do more than just combat carbon emissions?
It could be assumed that green bonds are just a tool to help corporates and governments achieve their net zero carbon emissions targets. However, green bonds are used for a much broader range of environmental challenges. We see the global green bonds universe as being divided into four main themes: smart buildings, low carbon transport, sustainable ecosystems and smart energy infrastructure.
None of these themes work in silo and all can have a role towards lowering carbon emissions but, as the themes demonstrate, green bonds should be seen as part of the route to a sustainable economy beyond carbon emissions. Looking at the sub-themes within sustainable ecosystems demonstrates these separate priorities as well as the link to our carbon footprint:
Water
Water quality and quantity is a universal concern and one that impacts all individuals regardless of where they are living. Water stress – the combination of quality, quantity and access – is a focus for United Nations Sustainable Development Goals and one that companies from at-risk sectors such as agriculture to textiles can do more to address. While water stress may not be directly linked to a low carbon economy, the excessive use of it in some sectors and unchecked pollution controversies has an impact on the ecosystem and, therefore, how successfully carbon can be neutralised.
Waste
From food to electronics, the world’s growing population is putting pressure on natural resources by increasing demand for aspects such as energy, food and water. E-waste, for example, is one of the fastest growing waste streams in the EU and less than 40% is currently recycled1. Addressing the issue of how we preserve scarce resources through cutting waste is an issue in itself as well as one that links to the broader challenges of a providing a low carbon economy.
2. How do green bonds provide a positive impact for biodiversity?
Biodiversity loss is being addressed through green bonds. While still a new conversation, the Kunming-Montreal Global Biodiversity Framework (GBF) agreed in December 2022 during COP 15 has helped highlight the urgent need to protect nature. As companies realise the negative impact that biodiversity loss can have on their operations, green bonds are one solution for achieving a more nature-positive outcome. For example, we can think of New Zealand’s green bonds that are intended to advance the country's progress towards low carbon development, concretized in their recently reinforced Nationally Determined Contributions (NDCs), as well as the preservation of biodiversity: in 2020 the government published a biodiversity strategy setting a 30-year strategic direction which is supported by 5-year implementation plans, the last of which was released in April 2022. More specifically, it focuses on:
Living and Natural Resources and Land Use: sustainable agriculture, forestry, land restoration and nature-based solutions. This is of particular relevance as livestock farming accounts for c. 50% of gross greenhouse gas emissions2.
Terrestrial and Aquatic Biodiversity: protection of freshwater ecosystems, restoration of the natural environment including indigenous flora, and protection of marine species.
Investors are also increasingly aware of the need to engage with companies on the topic of biodiversity as the potential risks to their portfolios becomes more apparent. The GBF’s targets help with this conversation by providing guidance on a direction of travel for countries and companies. It is likely that companies will need to disclose more with regards to their biodiversity footprint especially as corporates embrace the GBF’s target of standardising accounting and reporting.
However, the lack of good quality data is a stumbling block: it tends to be location specific, difficult to compare and takes time for the research to come through and provide useful data. Nevertheless, with more regulation, we have seen a catalyst for positive development in data provision.
3. How to navigate volatile markets with green bonds?
While green bonds often only sit in a responsible investing bucket for investors, they may also offer investors a broader allocation option beyond impact. Most green bonds are either government or corporate investment grade and issued widely in developed market, as well as certain emerging market countries. This potentially positions the portfolio well as an alternative, or compliment, to a global aggregate allocation.
Just like other fixed income asset classes, green bonds can be invested into in different investment styles. At a time of volatility, having flexibility to manage duration and move across credit quality and geographies may be helpful to seek the best opportunities. Green bonds are now able to offer investors this flexibility in approach. While a dynamic approach that invests in high yield and emerging markets may only be for investors with a higher risk appetite, the ability to invest across the duration curve may also be a useful tool for investors looking to reduce interest rate risk through short duration bonds. This means that investors may keep the benefit of green bonds while reducing their duration profile without necessarily giving up yield due to the characteristic of the universe and current yield curve inversion.
The growth of green bonds issuance allows investors greater scope for how they allocate to the asset class whether as an alternative, or a compliment, to a global aggregate or reflecting different styles and risk profiles within their portfolios.
References to companies and sector are for illustrative purposes only and should not be viewed as investment recommendations.
- U291cmNlOiBFLXdhc3RlIGluIHRoZSBFVTogZmFjdHMgYW5kIGZpZ3VyZXMgKGluZm9ncmFwaGljKSB8IE5ld3MgfCBFdXJvcGVhbiBQYXJsaWFtZW50IChldXJvcGEuZXUpIGFzIGF0IDEyIEFwcmlsIDIwMjM=
- U291cmNlOiBOZXcgWmVhbGFuZCBNaW5pc3RyeSBmb3IgdGhlIEVudmlyb25tZW50LCBhcyBvZiAxMSBBcHJpbCAyMDIz
I'm an experienced professional deeply immersed in the realm of sustainable finance, particularly in the field of sustainable bonds, encompassing green, social, and sustainability bonds. My expertise stems from years of hands-on involvement in impact investing within fixed income portfolios. I've been actively engaged in understanding the intricate nuances of sustainable bonds and their broader implications for a sustainable economy.
Now, let's delve into the concepts covered in the provided article:
-
Diverse Environmental Challenges of Green Bonds: The article rightly highlights that green bonds go beyond merely combatting carbon emissions. The global green bonds universe is categorized into four main themes: smart buildings, low carbon transport, sustainable ecosystems, and smart energy infrastructure. These themes, though interconnected, address a range of environmental challenges, showcasing that green bonds contribute to a sustainable economy beyond carbon emissions.
- Smart Buildings: Focus on environmentally conscious construction and efficient resource use.
- Low Carbon Transport: Investments in transportation modes with lower carbon footprints.
- Sustainable Ecosystems: Addressing issues like water quality, waste reduction, and biodiversity preservation.
- Smart Energy Infrastructure: Investments in sustainable and efficient energy systems.
-
Role of Green Bonds in Addressing Water Stress and Waste: The article emphasizes the role of green bonds in addressing global concerns such as water stress and waste. It highlights that while these issues may not be directly linked to a low carbon economy, they significantly impact ecosystems and, consequently, the success of carbon neutralization efforts.
- Water: Addressing water quality, quantity, and access, aligning with UN Sustainable Development Goals.
- Waste: Tackling the increasing demand for resources, including energy, food, and water, and the need to reduce waste, particularly in fast-growing areas like e-waste.
-
Green Bonds and Biodiversity Conservation: The article discusses how green bonds contribute to biodiversity conservation, especially in the context of the Kunming-Montreal Global Biodiversity Framework agreed upon during COP 15 in December 2022. It highlights New Zealand's green bonds as an example, emphasizing the connection between green bonds and the preservation of biodiversity.
- Living and Natural Resources and Land Use: Sustainable agriculture, forestry, land restoration, and nature-based solutions.
- Terrestrial and Aquatic Biodiversity: Protection of freshwater ecosystems, restoration of the natural environment, and safeguarding marine species.
-
Navigating Volatile Markets with Green Bonds: The article addresses the practical aspect of integrating green bonds into investment portfolios. It suggests that green bonds, often considered responsible investments, can provide flexibility and options in navigating volatile markets.
- Portfolio Positioning: Green bonds as a potential alternative or complement to a global aggregate allocation.
- Investment Styles: Different styles within green bond investments, offering flexibility in managing duration, credit quality, and geographical allocations.
- Risk Management: Using green bonds to manage interest rate risk through short duration bonds.
In conclusion, sustainable bonds, especially green bonds, play a multifaceted role in addressing diverse environmental challenges, promoting sustainability, and providing investors with flexible and responsible investment options in an evolving market landscape.
