Understanding Green Bond Performance in Market Setbacks

09 September 2022

7 min read

Erin Bigley, CFA| Chief Responsibility Officer

Tiffanie Wong, CFA| Director—Fixed Income Responsible Investing Portfolio Management; Director—Global & US Investment-Grade Credit

Patrick O'Connell, CFA| Director—Fixed Income Responsible Investing Research

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.

Green Bonds Can Still Provide Downside Mitigation

But Greenium Grew by a Smaller Magnitude During the 1H 2022 Sell-Off than in 1H 2020

Greeniums exceeded -40 basis points in late March/early April 2020 and reached -15 basis points in mid-June 2022

Historical analysis does not guarantee future results.
Green bonds are represented by the ICE EUR Corporate Green Bond Index; investment-grade bonds are represented by the ICE Bank of America 5–10 Year Euro Corporate Index.
Greenium refers to pricing benefits based on the logic that investors are willing to pay extra or accept lower yields in exchange for sustainable impact.
As of June 30, 2022
Source: Bloomberg, ICE Green Bond Index data and AllianceBernstein (AB)

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.)

Rising Performance Dispersion Warrants Diligent Differentiation

From January through June 2022, the change in the greenium for 100 representative bonds ranged from -53.4 b.p. to + 22 b.p.

Historical analysis does not guarantee future results.
Green bonds are represented by the ICE EUR Corporate Green Bond Index. Investment-grade bonds are represented by the ICE BofA 5–10 Year Euro Corporate Index. Chart assumes that greeniums are measured by the average spread of all the bonds in a ticker versus all the green bonds for a ticker. The extreme tails on top and bottom are cut off.
As of June 30, 2022
Source: Bloomberg, ICE Green Bond Index data and AB

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.

Green Bonds Include More BBB-Rated Issues Since 2020

Compared to 2020 the current green bond market has far fewer issues rated A3 or above and 22.4% more rated BBB1 through BBB3.

Historical analysis does not guarantee future results.
Green bond index is ICE EUR Corporate Green Bond Index.
Current index data as of June 30, 2022
Source: Bloomberg, ICE Bond indices and AB

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 and are subject to change over time.

About the Authors

Erin Bigley, CFA

Erin Bigley is a Senior Vice President, AB’s Chief Responsibility Officer, and a member of the firm’s Operating Committee and Women’s Leadership Council. In this role, she oversees AB’s responsible investing strategy, including integrating material environmental, social and governance considerations throughout the firm’s research, engagement and investment processes. Bigley joined the firm in 1997 and previously served as a portfolio manager and trader for the global and Canadian bond strategies. She spent two years based in London as the global head of Fixed Income Business Development for institutional clients. Bigley served as a fixed-income senior investment strategist for over a decade, and as head of the strategist team from 2018 to 2021. Prior to taking her current role, she served as head of Fixed Income Responsible Investing, overseeing the Fixed Income team’s responsible investing strategy. Bigley holds a BS in civil engineering from Villanova University and an MBA from the Massachusetts Institute of Technology’s Sloan School of Management. She is a CFA charterholder. Location: New York

Tiffanie Wong, CFA

Tiffanie Wong is a Senior Vice President and Director of Fixed Income Responsible Investing Portfolio Management. In this role, she is part of the leadership team that develops responsible investment strategy across AB's Fixed Income business, particularly related to integrating environmental, social and governance considerations throughout the team's portfolio construction processes and overseeing management of several of the team's sustainable strategies. Wong also serves as Director of Global & US Investment-Grade Credit, responsible for the management and strategy implementation of the firm's Global & US Investment-Grade Credit portfolios, including total-return and income-oriented credit strategies for institutional and retail clients. She has worked closely with AB's Quantitative Research team to leverage the firm's technology innovations within fixed-income trading and research to apply a more systematic approach to AB's credit investing. Prior to joining AB's Fixed Income portfolio-management team, Wong served as an associate portfolio manager on the Credit team, focusing on various strategies for the Global and US Credit portfolios—including total return, buy and hold, and liability matching. Before joining AB in 2012, she was a fixed-income portfolio analyst and trader at Segall Bryant & Hamill and a fixed-income portfolio associate at Wells Capital Management. Wong holds a BA in economics with a minor in business institutions from Northwestern University and is a CFA charterholder. Location: New York

Patrick O'Connell, CFA

Patrick O'Connell is a Senior Vice President and Director of Fixed Income Responsible Investing Research. In this role, he is part of the leadership team that develops responsible investment strategy across AB's Fixed Income business, particularly related to integrating environmental, social and governance considerations throughout the team's research and engagement. Previously, O'Connell served as a corporate credit research analyst, focusing on emerging-market corporates in Latin American and African countries. He joined the Emerging Markets research team in 2013 after working as a credit analyst covering US high-yield energy credits at AB. Prior to joining the firm in 2012, O'Connell was a desk analyst at UBS Investment Bank, where he helped to allocate capital on the trading desk. He holds a BS in accounting and finance (magna cum laude) from Villanova University and is a CFA charterholder. Location: New York

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Understanding Green Bond Performance in Market Setbacks

Getting a Grip on the Greenium

Bond Market Changes Drive More Differentiated Performance

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