Green bonds have gained a reputation for providing better downside mitigation than their conventional peers. But in this year’s market downturn, green bonds’ defensive performance patterns were mixed. What does this mean for investors?

We believe that the greater performance dispersion we’ve seen so far in 2022 makes a strong case for an active approach to investing in green bonds. With so many green bonds outstanding today, investors need sharper insights to help differentiate among them and to better understand each bond’s performance characteristics.

Getting a Grip on the Greenium

Green bonds have typically been more highly valued than their conventional counterparts, and consequently have generally traded at somewhat higher prices and lower yields. Expressed differently, a green bond typically exhibits a negative yield premium to conventional peers, also known as a “greenium.” When a green bond’s greenium gets bigger (negative yield premium becomes more negative), it outperforms comparable conventional bonds. So growth of the greenium is positive for a green bond’s performance.

While in the 2020 risk-off period greeniums grew in lockstep, in 2022 greeniums moved to a lesser extent (Display) and with greater dispersion—and in a minority of cases, green bonds didn’t outperform at all.

Market data across 100 representative euro-denominated corporate bonds show significant dispersion in performance across green bonds in the year to date. Although 80% of issuers saw their greeniums become more negative in the first half of the year (thus outperforming their conventional counterparts), 20% didn’t, and so displayed no favorable downside mitigation characteristics (Display).

What’s more, of the 80% of green bonds that saw their greenium increase, the magnitude of the changes differed materially, ranging from a few basis points (modest downside mitigation) to half a percentage point (strong downside mitigation). This market behavior makes a compelling argument for an active approach to green bond investing and reinforces the idea that not all green bonds should be regarded as equal. (In fact, we recently set out a ;comprehensive framework to analyze green bonds ;and other ESG-labeled structures.)

Bond Market Changes Drive More Differentiated Performance

Does that mean that green bonds’ defensive characteristics are eroding? Not necessarily. We think that green bonds can still offer favorable risk-mitigating characteristics relative to their conventional peers, but investors need to allow for several changes in bond markets that result from the increasing popularity of responsible investing. Although these will likely impact the size of the greenium, they are also helping to create a larger, broader universe of green bonds.

1. Increased Issuance. Green investing is moving into the mainstream. As the market matures, we have seen a significant increase in green bond issuance resulting in less scarcity value being assigned to some of these bonds, creating a more balanced dynamic between supply and demand.
2. Wider Sector Representation. Higher issuance has also led to green bonds being issued across a wider range of sectors. Accordingly, the composition of the green bond universe has also changed over time: more skewed to cyclical sectors, less skewed to more stable sectors like utilities. This may have resulted in a higher sensitivity to changes in the growth environment in the first half of 2022 than during the first half of 2020.
3. Lower Average Ratings. Increased issuance has created greater depth and diversity in the green bond market, not only across sectors but also across quality tiers. This has resulted in a lower average rating for green bonds (Display) and consequently higher credit sensitivity. This may have contributed to a decrease in the resilience of green bonds overall during risk-off periods in 2022.
4. Wider Investor Base. Investor demand has changed too. The buyer base has expanded for green bond structures, and demand is consequently no longer driven solely by investors with longer-term horizons, such as institutions. More investors are embracing responsible investing and responding to changes in the regulatory environment, such as in the context of the EU’s Sustainable Finance Disclosure Regulation (SFDR).

Over time we would expect investors to become less willing to pay a greenium for weaker structures, particularly where the use of proceeds is only loosely linked to eligible green projects, or where the issuer and its industry could be more susceptible to greenwashing allegations. Conversely, strong issues should be more likely to continue to attract a buyer base willing to pay a greenium for quality bonds. These include, for instance, green bonds that have full EU taxonomy alignment and whose issuer has very strong sustainability credentials.

We think that investors can still find green bonds with defensive characteristics. But we’ve also observed that the breadth and depth of the green bond market has significantly increased. That means investors need to differentiate more rigorously between green bond structures, based on careful evaluation of the characteristics of each individual issue.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

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AllianceBernstein

AllianceBernstein

AllianceBernstein (AB) is a leading global investment management firm that offers high-quality research and diversified investment services to institutional investors, individuals, and private wealth clients in major world markets. We believe corporate responsibility, responsible investing and stewardship are intertwined. To be effective stewards of our clients’ assets, we strive to invest responsibly—assessing, engaging on and integrating material issues, including environmental, social and governance (ESG), and climate change considerations in most of our actively managed strategies. We also believe that being a responsible firm allows us to be more responsible investors. Our stewardship practices, investment strategy and decision-making are guided by our purpose, mission and values.

Our purpose—pursue insight that unlocks opportunity—inspires our firm to act responsibly. While opportunity means something different to each of our stakeholders; it always means considering the unique goals of each stakeholder that go beyond the desire for financial returns. AB’s mission is to help our clients define and achieve their investment goals, explicitly stating what we do each day to unlock opportunity for our clients. We became a signatory to the Principles for Responsible Investment (PRI) in 2011. This formalized our commitment to identify responsible ways to unlock opportunities for our clients through ESG integration in most of our actively managed equity and fixed-income client accounts, funds and strategies.

Because we are an active manager, our differentiated insights drive our ability to deliver alpha and design innovative investment solutions. ESG and climate issues are key elements in forming insights and in presenting potential risks and opportunities that can have an impact on the performance of the companies and issuers that we invest in and the portfolios that we build.

Our values provide a framework for the behaviors and actions that deliver on our purpose and mission. Values align our actions. Each value emerges from the firm’s collective character—yet is also aspirational. Each value challenges us to become a more responsible version of AB.

• Invest in One Another means that we have a strong organizational culture where diversity is celebrated and mentorship is critical to our success. When we invest in one another, we empower our employees to reach their potential, so that they can help our clients realize theirs. This enables us to partner with clients to design and deliver improved investment outcomes.
• Strive for Distinctive Knowledge means that we collaboratively identify creative solutions to clients’ economic, ESG and climate- related investment challenges through our expertise in a wide range of investment disciplines, close collaboration among our investment experts and creative solutions.
• Speak with Courage and Conviction informs how we engage our AB colleagues and issuers. We seek to learn from other parts of our business to strengthen our own views. And we engage issuers for insight and action by sharing ideas and best practices.
• Act with Integrity—Always is the bedrock of our relationships and has specific meaning for our business. Unlike many other asset managers, we’re singularly focused on providing asset management and research to our clients. We don’t engage in activities that could be distracting, or create conflicts—such as investment banking, insurance writing, commercial banking or proprietary trading for our own account. We are unconflicted and fully accountable.

As of December 31, 2022, AB had $646B in assets under management, $445B of which were ESG-integrated. Additional information about AB may be found on our website, www.alliancebernstein.com.

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