2023: The year of green, social and sustainability bonds? Three reasons to be optimistic
- The transition to net zero requires massive investment, bringing new potential opportunities for investors in green, social and sustainability bonds
- We believe such bonds are well positioned to benefit from an improving economic environment, attractive valuations and growing investor appetite
- It is important to remain selective and invest in meaningful projects from credible issuers
2022 was a very challenging year for the bond market and sustainable bonds were no exception. Yet, there are reasons to remain optimistic about the asset class; the green bond market showed resilience and offered interesting investment opportunities which continued to drive investor appetite despite the high volatility. 2023 might be the year of the bond market revival.1 Uncertainties remain high but there are growing signs that headline inflation is abating, growth is coping better than expected and central banks’ tightening cycles might soon come to an end. This context should be particularly favourable to the green, social and sustainability bond market.
As regulation steps in and strengthens scrutiny over sustainable investment, green, social and sustainability bonds should further benefit from the transparency they provide. Looking at green bonds, our research has demonstrated the carbon intensity of the projects financed are, on average, less than half that of the companies issuing the bonds.2 Therefore, they are fulfilling their primary role of financing projects with a positive impact on the environment while also offering investors a market that is liquid3 and growing in its potential to achieve large tradeable volumes.
We have identified three reasons for optimism for the green, social and sustainability bond market in 2023:
A very dynamic market
Amid 2022’s turbulent economic conditions, green, social and sustainability bonds still registered $606bn of new issuances,4 mainly driven by the green bond market, which accounted for almost $400bn of issuance. 2022 managed to keep apace with 2021’s record in terms of issuance volumes in the green bond market, and the year welcomed an additional 115 new issuers.
Credit accounted for more than 50% of total issuances for the third consecutive year, thanks to an increasing sector diversification coming from the real estate, automotive, consumer goods and telecommunication sectors. Meanwhile, sovereign issuance continued to pick up, with countries such as Austria and Canada issuing their first green bonds.
This reflects not only the credibility of green bonds when it comes to supporting the financing needs of the net zero transition but also that every sector is progressively investing in the transition. Looking ahead, there are reasons to believe this sector diversification should also be accompanied with greater regional diversification. One could expect higher issuance for US corporates, especially on the back of the US Inflation Reduction Act, while emerging market issuance should continue to pick up as a successful global transition cannot be achieved without significant investment in the area.
The social and sustainability bond market dynamic was a bit more nuanced. Yet, it is worth highlighting that we saw the first social bond issuance from a real estate company, potentially paving the way for more corporate bond issuances from the segment. Meanwhile, digging into the sustainability bond dynamic, it is worth noting the strong contribution of US dollar issuances compared to green and social bonds which remain dominated by euro issuances. These dynamics continue to bring a wide range of diversified potential investment opportunities from both a sector and geographical perspective.
The rebound in yield levels at the end of 2022 has helped valuations look increasingly attractive. In the short term, the picture remains uncertain: Central banks continue to pursue their tightening cycle to bring both headline and core inflation down and the bond supply pipeline looks incredibly heavy over the first quarter. Yet, the long-term picture looks more and more compelling for the bond market and should be particularly beneficial to the green, social and sustainability universe given its credit exposure and sensitivity to interest rates.
Indeed, we believe that some of the factors that explained the underperformance of the green, social and sustainability bonds universe compared to conventional bonds in 2022 will reverse in 2023. The universe currently enjoys an attractive yield pick-up compared to conventional bonds and looks better positioned to benefit from a decline in yields and compression of credit spreads.
Growing investor appetite
Sustainable strategies have benefited from growing investor appetite over recent years. As regulation tightens, it is crucial to be able to continue to demonstrate the credibility of these strategies. Green, social and sustainability bonds offer a very appropriate instrument which combines transparency and measurability of the projects funded. We believe this should be particularly beneficial to the asset class and potentially attract both new investors and new issuers.
The transition to net zero requires massive investments over the coming years. For example, a recent study5 showed an extra $3.5trn a year is needed in capital spending on physical assets for energy and land use systems to meet 2050 targets. Initiatives such as RePowerEU or the US’s Inflation Reduction Act are likely to support these investments and should be beneficial to the asset class.
On the social side, the strikes and cost-of-living-related challenges are exasperating the inequalities across populations. Alongside this, low-income households in developed and developing countries are on the front line when it comes to bearing the cost of both climate change disasters and a transition to net zero. With this in mind, we could see a resurgence in social bonds in 2023 with a growing focus on the social pillar.
If the perspectives are positive for the market, investors should nevertheless remain cautious when investing in sustainable bonds. The crux is the ability of asset managers to invest in meaningful projects from credible issuers though a strong analysis. The capabilities of the asset manager are key here and therefore we have developed a powerful framework that allows us to be very selective on this market.
Finally, we will closely follow and contribute to the evolution of the regulation pertaining to the upcoming green then social taxonomies, how they will work with the Sustainable Finance Disclosure Regulation (SFDR) and the current local ones – no doubt we will all need to adapt, but these should not impede our increased ambition to contribute to a green and just transition.
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