The global sustainability-linked bond market has seen dramatic growth in 2020, and investors are evaluating whether the sustainability and value propositions align.
JP Morgan Asset Management research found that sustainable fixed income globally saw EUR 59 billion of inflows in 2020, a 39% increase versus 2019, driven by investors, companies, regulators and governments aligning behind the goals of the Paris Agreement. Issuance of green, social and sustainable bonds is soaring, from USD 565 billion in 2019 to USD 732 billion in 2020.
While the market of sustainable fixed income - which includes green bonds, social bonds and sustainability-linked bonds - is broadening and deepening, bonds still need to stack up on the investment side, as well as having transparent reporting on the underlying assets.
JP Morgan Asset Management notes that green bonds have to meet investment criteria on fundamental, technical factor and quantitative valuation grounds, and note that some sustainable bonds fall short on valuations.
"We run a global multisector fixed income fund with a total return objective," said Liam Moore, a fixed income investment specialist at JP Morgan Asset Management. "It doesn't always make sense to invest in these bonds just because they're green - you have to have an attractive yield."
It is reasonable to expect a green or sustainable bond to yield slightly less than its non-green counterpart, but given that index spreads are tight, "'slightly less' is a significant discount," the fund manager noted.
"Generally speaking, we see green bonds and non-green tracking fairly closely," Moore said. "There is not much scope for a massive widening over the longer term or a time where you'd have a different credit rating for a green bond versus a non-green bond. You're ultimately taking on the credit risk of the issuer, and that's where the credit ratings are likely to be consistent across the different types."
But there is strong demand coming from investors who are seeking the co-benefits of green bonds.
"Some may be impact funds, where they're seeing that the use of proceeds are going to a green project," he noted. "Other investors may just want to see that the company is on the right track, without needing to see the use of proceeds. That's where sustainability linked bonds may come in. Sustainably bonds focus on the output rather than the use of proceeds, that's an interesting growth for the marketplace."
JP Morgan Asset Management also found that "what has previously been a European-dominated market is now broadening out, with the US dollar looking set to become the primary currency for sustainable financing in 2021."
"It's fair to say that Europe has been more focused on ESG and sustainability over recent years, but the US market is catching up and we're seeing an increase in interest in ESG issuance in the US," Moore said. "We are seeing that US dollar issuance is growing and more generally, a more diverse mix of issuance. Around a fifth of issuance is in emerging markets now, there's a mix of sovereign and corporate. Issuance isn't confined to just corporates and it is growing across the board. We've seen significant growth in the sovereign space as well."
Recent issuance has come from a wide range of sectors, led by utilities, banks, REITs and technology, JP Morgan noted.
"We do think there needs to be an element of verification, whether that's a green bond standard, the ICMA principles, or whether it comes down to individual bonds getting a second opinion, that to us is key, because effectively it keeps companies in check and ultimately prevents greenwashing.
"Generally speaking, issuers we've been seeing have second party assurance. It's extremely important to get that and validate the goals, especially with sustainability linked bonds, to make sure that the coupon step up is sufficient, the targets are reasonable and that companies are issuing in the spirit of sustainability."