Many investors continue to focus attention on financial instruments which, alongside producing an investment return, also aim to aid progress towards a more sustainable and inclusive economy. Green, Social, and Sustainability (GSS) bonds have emerged as a mechanism for directing capital towards projects which address critical global issues such as climate change, biodiversity, social advancement and sustainable economic growth.
These “use of proceeds” bonds are designed to fund specific projects with clear environmental or social benefits, there by aligning the interests of investors with broader sustainable goals.
The GSS market is maturing into a large and well diversified segment, offering bond investors the opportunity to better align portfolios with their sustainable objectives.
An illustrious career: the GSS journey so far
In 2012 the GSS bond market was just getting warmed up, with issuance amounting to only USD 5.2 billion dollars that year, according to LSEG Eikon.
Today, this market is demonstrating very steady annual issuance dynamics: almost USD 400 billion in the first half of 2024 and USD 900 billion on average over the previous two years. Prior to the pandemic, the use of proceeds market was dominated by the growth of green bond issuance.
This was largely driven by a broader awareness of environmental challenges, regulatory and policy changes, and increased demands on investment managers to explicitly consider environmental issues in investment decision making.
Since 2020, green issuance has been joined by an increase in social and sustainable bond issuance, with Covid-19 helping to bring social issues into sharper focus. The net effect is a bigger and more varied market. Today, the GSS bond market stands at USD 4.1 trillion, with 38% of that in social and sustainability bonds.
What makes up the GSS market?
As the GSS market becomes more varied by the type of bond label, diversification is also emerging in the regional and sector make-up of the market. Europe still dominates geographically, reflecting the ongoing demand for sustainable investment solutions across the region and the evolving regulatory backdrop.
Asia is the second largest issuer of GSS bonds, with 23% of issuance year to date and 31% over the previous two years. The US represents only 13% of debt outstanding and there is little sign of change: on average, the US has accounted for 13% of the last five years’ GSS bond issuance.
Green US Treasury bonds are particularly notable by their absence. An entry into the GSS market by the US government was mooted earlier in the year and, should it occur, the GSS market would more closely resemble the broader global aggregate bond market.
From an issuer perspective, the heterogeneous nature of fixed income markets is becoming better reflected in the use of proceeds universe. Of all GSS debt outstanding today, half is now issued by corporates, with the rest broadly split across government, municipal, agency, multi-lateral and supranational issuers.
There is still a significantly higher concentration in corporates compared to the Bloomberg Global Aggregate Bond Index, but the arrival on the scene of social and sustainability bonds has altered the universe’s composition.
If we were to examine just the green bond market, corporates would make up almost two thirds of debt outstanding. Sector-wise, financial issuers are the most prolific, consistent with non-GSS corporate markets, driven by substantial regulatory funding requirements.
Electric utilities, perhaps unsurprisingly, are also prominent issuers, given their direct business involvement in power generation drawn from fossil fuels. The sector is seeing a strong move to decarbonisation and green bonds are being used to finance renewable energy and energy efficiency related projects.
Does GSS bond investing come at a cost?
Because GSS bonds can offer transparency around the use of capital and a clear link to sustainable objectives, there can sometimes be increased demand for such instruments, resulting in a premium – a lower yield – versus general purpose bonds from the same issuer.
The presence and extent of a green premium, or ‘greenium’, varies by sector and issuer. While sometimes it doesn’t exist at all, it’s also not unusual to see a 5-10 basis point yield give up on an individual bond basis.
This has led to scepticism about the return prospects of a GSS portfolio – particularly in the previous regime of near-zero interest rates, where every basis point counted as a bigger proportion of all-in yield.
Fixed income portfolios, which are typically very well-diversified with a large number of individual bonds and issuers, can however be considered from a top-down, as well as bottom-up, perspective.
In 2022, Bloomberg launched its Global Aggregate Green, Social & Sustainability Bond Index, reflecting the growth in this market and growing interest from investors. This index – with Global Aggregate in its name (unlike the earlier Bloomberg MSCI Green Bond Index) – reflects in several ways the core, high-quality characteristics of the broader Global Aggregate Index.
In terms of headline risk profile, the duration and quality of the GSS and the Global Aggregate Indices are broadly similar. Most notably, the GSS index offers a slightly higher yield than the broader Global Agg - 4.9% versus 4.7%, hedged to USD.
This will come as a surprise to investors focused on avoiding a greenium. It can be explained by the underlying sector composition in the two markets: as we’ve discussed, there are no green US Treasuries, which are a significant portion of the Global Agg.
There are also no green Japanese Government Bonds (yet), which would serve as a drag on yield. Accordingly, there is more exposure to spread sectors within the GSS universe.
Thus, while a greenium effect may mean that individual underlying bonds in the GSS universe yield slightly less than their traditional counterparts in the Global Agg, this is offset by the sector and issuer composition resulting in a marginally higher all-in yield.
What does this mean for returns?
It’s challenging to get a long-term look back on realised performance of a GSS index versus a ‘traditional’ index, because of the changing issuance landscape over the years and the nascence of the GSS market. With that caveat acknowledged, there is a very high correlation of returns between the two indices since the launch of the GSS Agg (0.98 based on monthly return data since the end of 2022).
Directionally, total returns have tracked closely with one another, albeit with some divergence due to the relative credit overweight in the GSS market in a period of tightening spreads and stable rates.
With all else equal, this could reverse in a risk-off, contractionary scenario where credit spreads widen and core rates fall. Nevertheless, a high correlation over time with the Global Agg, combined with increasing size and liquidity, suggests that investors can regard the GSS market as a suitable core holding in a fixed income portfolio.
The JPM Green Social Sustainable Bond UCITS ETF* allows investors to access opportunities in the GSS market.
The active ETF was launched in February 2023 and offers a diversified portfolio, invested across investment grade and high yield credit, as well as sovereigns and supra-national organisations. It has a sustainable investment objective, underpinned by a robust risk management and governance framework aligned with SFDR Article 9.
The portfolio management team uses a proprietary sustainable issuance framework, supported by traditional fundamental, quantitative and technical research.
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