Rising Above the Noise in ESG: Green Bonds

The emergence of ethical and sustainable concerns and the need for environmental investing has come with a wide range of options for fixed income market participants to navigate. One approach has been to rely on evaluation metrics, or ratings that measure the environmental and social impact of companies’ operations. The main challenge of this approach is that currently there is no clear standard of measurement in the market. Researchers at MIT working on the Aggregate Confusion Project found that when they compared “two of the top five ESG rating agencies and compute the rank correlation across firms in a particular year, we are likely to obtain a correlation of the order of 10 to 15 percent. At least the correlation is positive! It is very likely (about 5 to 10 percent of the firms) that the firm that is in the top 5 percent for one rating agency belongs to the bottom 20 percent for the other.”

Green bonds offer an opportunity for market participants to add an element of impact investing into their core exposure in a simple way. Green bonds are not too different than traditional bonds. They work in the same ways as traditional bonds and are issued by a similar issuer base. The key difference between a green bond and a traditional bond is that with a green bond, the issuer lets us know that the proceeds are earmarked for investments in projects that have environmental benefits.

The S&P Green Bond Index is designed to track the global green bond market. However, since green bonds are self-identified, market participants need independent, expert-led guidance on which investments are part of a low-carbon economy. This will ease decision-making and focus attention on credible climate change solution opportunities. In the selection process for the index, S&P DJI partners with the Climate Bond Initiative, which certifies and monitors the usage of proceeds on an ongoing basis. This approach is straightforward and doesn’t require the sophisticated analysis of a company’s behavior.

Historical performance of green bonds has been much like the ubiquitous aggregate index. Over the past year, when regressing the daily returns between the S&P Green Bond Select Index and the Barclays Global Aggregate, there is a 0.93 correlation, a slope of 0.97, and a small positive alpha (see Exhibit 1). That means that market participants looking to green up their portfolio may not need to sacrifice performance. In fact, over the one-year period, the S&P Green Bond Select Index outperformed the Barclays Global Aggregate in U.S. dollar terms (see Exhibit 2).

To tune-in to a further discussion of this topic, please see here.

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