Yields of green: higher, lower, or the same?
ESG investing is gaining momentum around the world, with capital flowing increasingly into ventures and companies with a sustainable focus. That trend cuts across asset classes, including sustainable fixed income.
According to the IMF, green bonds are leading the charge in sustainable fixed income, spurred by strong investor demand to reach an estimated US$590 million as of August 2019. Europe is the top region in terms green-bond issuance, with North America and Asia, most notably China, also playing a significant part.
The existence of green bonds presents an opportunity to examine a major question in ESG investing: do sustainable investments provide higher, lower, or the same returns relative to those provided by comparable traditional investments?
“Many issuers issue traditional as well as certified green bonds that explicitly contribute to ESG-related goals,” said Bill Fung, PhD, and Joachim Klement, CFA, in a piece published by the CFA Institute.
“If the same issuer sells traditional and green bonds, both varieties have identical credit risk from the issuer’s perspective. But the traditional bonds may have higher [or lower] yield than the green bonds,” the pair said.
A sampling of the current literature on green bonds shows no clear consensus. The pair cited a Bank of International Settlements (BIS) study, which found that green bonds from the same issuer trade at lower yields, or higher prices, than their non-green counterparts. Yields of green bonds at issuance were anywhere from 10 bps (AAA-rated issuers) to 45 bps (A- and BBB-rated issuers) lower than non-labelled bonds from the same issuer, though the variance in the green bond premium was too high for the finding to be statistically significant.
“On the other hand, studies of US corporate and municipal bonds show green bonds trade at a yield premium relative to non-green bonds,” Fung and Klement said, noting how research from the Sorbonne found an 8 bps average yield premium for green vs. non-green bonds from the same issuer.
Another analysis by University Paris-Dauphine focused on bonds issued by French companies, which had to provide more transparency into their ESG risks to comply with regulatory changes. In that study, the authors found that neither green bonds nor bonds of companies with lower ESG risks exhibited a yield premium over comparable conventional issues.
Yet another study conducted by David Larcker and Edward Watts from Stanford University examined US municipal bonds issued by the same issuer — with some tranches certified green, and others not — at virtually the same time. “[They] found virtually no difference between the yields of green and non-green bonds once the controlled bond pairs in the comparison sample are properly adjusted for such fixed features as callability terms and other specific tax differences,” Fung and Klement said.
The studies varied in their conclusions, the two reasoned, because they measured performance based on “radically different assumptions about investor preferences in the green bond market.” Put another way, they said that investors may hold different views of ESG risks, which leads to variation in returns.
“[A] better understanding of how investors assess performance might provide important clues to determine how to measure this ever-illusive green premium,” they said. “[T]here may be structural differences between investors that buy green bonds and those that buy traditional bonds.”