Allocating to Green Bonds

Abstract

Green bonds are about a decade old financial instrument with cash flows earmarked to improve the environment or combat climate change. The author shows the spectacular growth of the asset class over time but notes that it is currently still less than 1% of the investment grade fixed income market. The composition of the asset class has changed considerably over time. At the start, it was mainly very safe supranational institutions issuing in various currencies with relatively short maturities. Corporates, especially utilities, followed them, and more recently, governments have started issuing green bonds. These sharp composition changes make historical data from before 2015 less representative for the future. The author’s returns- and characteristics-based analyses show that investors allocating to green bonds should finance this from an aggregate fixed income allocation if they want to reduce the impact on the risk and return characteristics of the existing portfolio.