Produced in partnership with AXA Investment Managers.
The green bond market has grown exponentially since the first issuance in 2007 by the European Investment Bank.
Since then, over 800 governments and corporations have entered the market, including the Australian Office of Financial Management, which issued its first Green Treasury Bond last year.
The AOFM, which issues debt securities on behalf of the Australian government, launched a $7 billion 2034 syndication on 3 June 2024. By early afternoon, the book reached $20 billion and ended the day over-subscribed with more than $22 billion in bids from 105 investors across Australia, Asia, Europe and North America. Around 65 per cent was allocated to local investors. The final order book represented more than three times the original transaction size, demonstrating strong investor demand for the asset class.
Around the world, there are plenty of similar stories, driving the volume of green bond issuance to surpass US$575 billion ($917 billion) in 2023, a year-on-year increase of 10 per cent, according to the S&P Global Sustainable Bond Report.
AXA Investment Managers predicts that green bond issuance could hit US$600 billion next year.
According to Johann Plé, senior fixed income manager for AXA IM, green bonds are one of the most appropriate instruments to support the transition to a low carbon economy, leading to the sector’s rapid growth.
“For investors, it combines potential financial returns with the ability to support specific climate and environmental projects that have measurable KPIs,” he tells Professional Planner.
“Over the past eight years, the sector has outperformed the global aggregate universe 6 times out of 8 because it has a good mix of credit and sovereign debt. With the current level of rates, green bonds could continue to deliver decent performance.”
But demand for green bonds hasn’t always been as strong as it is today. In the early days, the market didn’t have the breath or depth to provide adequate choice and diversification.
Between 2007 and 2015, the green bond market recorded only a handful of issuances per year.
It wasn’t until the 2015 Paris Agreement on climate change that interest from institutional and wholesale investors started to pick up.
Since then, global awareness and understanding of the importance and urgency of addressing climate change and other environmental issues has increased dramatically.
Regulators have also strengthened their frameworks around issuing green bonds to improve governance and transparency. These developments have significantly enhanced the sector’s credibility, sparking an increase in the number of issuances and buoying investor demand for environmentally responsible fixed income strategies.
The trend points to an asset class that is fast shedding its “niche” status and offering investors broad diversification, Plé says.
“There is dynamic primary market activity, as corporates represent half of issuances, which brings enormous diversification benefits in terms of sectors, issuers and regions,” he says.
“Initially, [corporate] issuances were concentrated in utilities and financials, but they progressively broadened to include real estate, telecommunications and transportation, and today feature almost every sector available in the conventional bond universe.”
In addition to sector diversification, there is plenty of “granularity” in terms of issue selection, which supports robust portfolio construction, Plé says.
“When constructing and managing a portfolio, you don’t need to buy the entire universe [to achieve adequate diversification],” he says.
“Generally, there are around 150-200 different issuers in a [conventional] global bond portfolio, so if there are over 800 issuers, you can find more than enough papers to implement your strategies.”
The number of asset managers offering green bond strategies has also increased markedly in recent years. AXA IM was a pioneer in this space, launching its flagship fund a decade ago.
Reputational risks to consider
“Not all green bonds are equal,” Plé says, and there is still no binding regulation, although the International Capital Markets Association has established the Green Bond Principles, a set of voluntary guidelines for issuers.
This makes it imperative for investors to have a rigorous approach to security and manager selection to avoid greenwashing and ensure a real environmental benefit.
“Anyone can come to market and label their projects green, which is why it is so important to have an inhouse framework for identifying and assessing projects and ensuring alignment between the project and the issuer’s mission, objectives and commitments,” he says.
For consideration in AXA IM’s portfolio, issuances must pass a number of criteria.
Firstly, the issuer must demonstrate to have a credible sustainable strategy with a meaningful commitment to decarbonization.
Secondly, projects must be truly green and have no negative impact on the environment. For example, AXA IM does not invest in large hydro power plants although hydroelectricity is an important source of renewable energy, because of their negative impact on biodiversity. These plants take up a lot of space, leading to habitat loss, wildlife displacement and land damage.
Finally, projects must be completely transparent so their impact can be measured with issuers providing allocation and impact reports that include the most relevant and reliable KPIs.
AXA IM’s investment and risk management framework is deliberately conservative to safeguard the group’s reputation and avoid greenwashing, which Plé says has two key dimensions: avoid investing in an issuer that is not committed to the green transition, and avoid supporting a project that is not truly green.
“It is critical to look beyond the green bond specifics and consider the actual issuer,” he says.
AXA IM has spent a lot of time and attention developing and refining its framework including defining the types of projects classified as truly green. For example, fossil energy-related projects are excluded, even natural gas. More than 25 per cent of the green bond universe is excluded, based on AXA IM’s definitions.
“That doesn’t mean that a quarter of the market is greenwashing, it just means that we are not comfortable with them,” Plé says.
“There are significant reputational risks when you claim to be doing things that are green and fail to deliver on that. We’d rather be conservative [in our assessment of projects and issuers] than complacent.
“Even if you do 90 per cent of things right, the focus will be on the 10 per cent that you didn’t get right, so you need to ensure that robust processes are in place to get it completely right.”
