Diverse green bonds will build the future faster

clock • 4 min read

Green bonds are about finding opportunities to invest in the future - and the future won't be uniform or standardised.

Investors are increasingly looking for bonds secured against the sustainable economy. Outstanding green bonds are now worth more than $600 billion globally, with issuance in 2020 expected to reach $250 billion. Amid this acceleration, different shades of green are emerging. Such diversity of green bonds has tangible benefits - to both investors and the planet.

There are three key ways in which a broader menu of green bonds is a significant advantage.

1.            Green economies will be diverse economies

Different projects and different activities require different forms of finance. As a result, the variety of green bonds can accelerate the transition towards an eventual zero carbon economy.

As a minimum standard, bonds labelled as ‘green' must allocate at least 95% of the capital invested to specifically green projects or assets. Yet beyond this essential definition, innovation is finding all kinds of opportunities. No single issuer nor every bond is identical, as the forces of competition, technical progress, and choice drive better outcomes.

While green bond issuance is accelerating fast, a staggering $6.3 trillion is needed annually until 2030 to meet global climate goals, according to the OECD. Not all of this capital will come specifically from green bonds, as other asset classes have a role too. But this sharp contrast implies green bond issuance needs to grow many times over in a few years.

Such substantial growth in green bond issuance will not happen if every issue follows the same structure, or if every green bond originates from the same narrow group of issuers. Likewise, green bonds need to fund an abundant variety of innovative real world investment opportunities.

2.            Diversification cuts climate and investor risk

In the words of Harry Markowitz, diversification is ‘the only free lunch'. In the long struggle to save the planet, a free lunch should be taken willingly!

Even beyond the eventual diversity of a sustainable economy, there will be many more ideas and projects that don't pay off to the same extent. Diversification of all kinds of factors - from geography to technology or investment strategy - is the best way to gain exposure to a wide range of successful opportunities.

For example, risk from any fixed income investment depends on the issuer of any security - not just the type of project being funded and any collateral. As a result, some investors in green bond funds add a further level of scrutiny on green bond issuers. One example is the screening of corporate issuers as well as these companies' individual projects.

These kinds of factors are in addition to the minimum green bond standard mentioned above, and allow a breadth of carefully diversified funds, suitable to a wider variety of investor.

3.            Financial innovation needs diversity 

Investors themselves are perhaps most vital to the growth of green bonds. Rapid understanding and uptake will depend on the right products and support being available. That challenge to innovate needs another kind of diversity - in this case from the financial world.

Customisable and diverse portfolios are only possible when a sufficient choice of investment products is easily accessible, with a sufficient variety of strategies.

Different kinds of investors will have particular preferences when considering green bond investments, best-suited to their investment timeframe, risk appetite and financial situation. Green bonds need to be studied and scrutinised by experts, then packaged into suitable, diversified and accessible financial products.

There has been a particular uptake in green bond ETFs for precisely this reason. Different kinds of investors are drawn to a product which allows greater transparency, simplicity, more choice and control over the underlying investment, and lower fees - all while channelling capital into the vital projects supported by underlying green bonds.

Given the relative infancy of the green bond opportunity set, most investors currently considering green bonds are doing so for the first time. In other words, the choice for most investors is between either non-climate-accredited investment alternatives, or a green bond of any kind.

Therefore, the vast majority of investments into green bonds are already shifting capital away from polluting activities into greener firms and projects. Consequently, all investors should be welcomed by the green bond industry.

Anything categorised as a ‘green bond' must already meeting stringent minimum standards, so there is arguably space for some projects that allow the transition to a green economy as well as the end goal of a zero carbon world. For example, if the financial system can allocate more capital to a green energy firm and allow a previously fossil fuel-dominated issuer to invest in a new greener solution, why not have investment products that fund both?

All kinds of investors are keen to follow the green bond trend, so we should provide all kinds of products to tap their enthusiasm - for the good of both the global climate, and the benefit of investment portfolios.

To summarise: in the very near future people won't be asking ‘why green bonds?' but rather, ‘why is this fixed income investment not green-accredited?' In this new world, all kinds of industries, ideas and investors must be welcome under the broadest possible green banner.

Matthieu Mouly is Chief Client Officer, Lyxor ETF