Green investments during the pandemic: Bond edition

We know that ESG funds with higher ESG ratings have fared better during the pandemic than traditional funds. And we also know that ESG investments tended to outperform but mostly because they are tilted towards the tech sector that outperformed during the pandemic. But what about bonds? And especially, what about the new category of green bonds?

Since green bonds are a relatively new invention, we are only slowly starting to understand how they behave over a cycle and in different market environments. We know that ESG bonds don’t seem to offer a yield premium or discount to comparable conventional bonds – at least not in the secondary market.

The Covid pandemic gave us a first chance to check how green bonds hold up in a crisis and recession. It could well be that green bonds underperform in a crisis as investors take flight into safe and well-known assets within the fixed income space. On the other hand, green bonds are green bonds because their cash flows are linked to specific green projects that were generally not in danger of stalling during the pandemic which means that default risks were probably somewhat lower than for regular corporate bonds. Serena Fatica and Roberto Panzica from the European Commission set out to examine how green bonds did during the pandemic market stress in 2020 and the news is good for issuers and investors of green bonds alike.

First, they found that green bonds on average outperformed conventional bonds during the initial market stress in spring 2020. Because green bonds tend to have longer maturities than conventional bonds, the index return for green bond indices seems to have been lower than for corporate bond indices but when adjusted for duration green bonds did indeed outperform.

Green bonds and conventional bonds in Europe in 2020

Source: Bloomberg

But much more important that pure performance is their analysis how investors treated green bonds in their portfolios. The research found in normal times (2018-2019) investors were no more likely to sell conventional bonds than green bonds. Essentially, green bonds were treated by investors like any other bond in their portfolios. However, that behaviour changed during the spring of 2020 when the pandemic stressed the market. During that time period investors were significantly more likely to sell conventional bonds from their portfolios than green bonds. Further investigation showed that this reluctance to sell green bonds wasn’t due to a lack of liquidity or a perceived scarcity of these bonds. No, investors simply held on to green bonds more because they seem to perceive them as less risky than conventional bonds. This is great news for investors because it means that green bonds are less volatile than comparable conventional bonds in times of market stress.

And that in turn shows that if you are a company thinking about issuing bonds, you should issue green bonds if you can. It looks like they enjoy a more stable and long-term oriented investor base.