Responsible bonds guide investors to the right path

Green bonds make up the largest share of the total responsible bond market. ‘Green bonds are essentially ordinary (straight)  bonds,’ says Thomas Dupont, Portfolio Manager at KBC Asset Management, ‘but with the difference being that the funds raised are used exclusively to finance green projects. Precisely what those green projects are will be disclosed by the bond issuer through a so-called ‘Green Bond Framework’.’ They include projects focusing on renewable energy or energy-efficiency, such as the building of energy-efficient homes or wind farms, sustainable use of natural resources such as smart water management, a focus on biodiversity or investments in sustainable transport or the circular economy. Both governments and companies can issue green bonds. 

The market for responsible bonds is growing rapidly and includes not only green bonds but also social bonds, intended to fund projects such as building schools, combating poverty or promoting employment and social housing, and sustainability bonds, which target both environmental and social objectives.

Responsible bonds have the same characteristics as conventional bonds. Apart from the obligation to use the funds raised from the bond issue to finance specific green or social projects, there is no difference between the two types of bond. ‘There is no reason to assume in advance any underperformance or outperformance. Consequently, the returns on such bonds are in line with those for conventional bonds,’ says Dupont.
There used to be a perception that responsible investing costs money or that you have to sacrifice returns for it. Quite a few scientific studies have now shown that responsibility doesn’t necessarily come at the expense of profitability. Far from it: there is in fact growing evidence that it can also work out the other way round. 

The term ‘greenium’ refers to the extra premium paid when a bond is labelled as responsible. The investor then receives a slightly lower payment than with a conventional bond. ‘The greenium was significant for a while because the demand from investors for this type of bond exceeded supply. As the market matures, this premium has become so small as to be almost non-existent,’ says Dupont. ‘I also can’t see a reason why that trend would reverse anytime soon.’

‘Textbook examples of green bonds issued by governments are the German ‘twin bonds’, where each green bond has a conventional counterpart with the same characteristics such as coupon or maturity. That makes the amount of the greenium absolutely transparent,’ Goeminne adds. ‘The returns on green government bonds with longer maturities do not differ significantly from their conventional counterparts. The greenium has all but disappeared here. For short green bonds, however, the difference in returns can add up quite significantly. After all, there are few truly short-dated bonds of this type available and so the oldest market wisdom comes into play again: the price is determined by supply and demand.’

Responsible bonds are not new; the first issues date back some 15 years. Since then, the volume of these bonds in circulation worldwide has continued to rise, reaching more than 1 700 billion dollars today. Green bonds, at over 1 150 billion USD, make up the largest share of this total. A total annual issuance of between 750 billion USD and 1000 billion USD is no longer unusual in recent years, and a similar amount of funds will also be raised in 2023. 

Socially and environmentally aware investors like to know what is done with their money. Transparency is therefore crucial.

‘We only select green, social or sustainability bonds that comply with the principles of the International Capital Markets Association (ICMA),’ Goeminne stresses.  That entails clear communication to investors about how the funds raised are spent, about the process used to select and evaluate projects, and about how the funds raised are managed. Issuers report to their stakeholders at least annually.

‘KBC Asset Management's Responsible Investment methodology also requires an external validation to confirm that the bond in question complies with the ICMA guidelines. This is an extra step that we build in to eliminate the risk of greenwashing as far as possible,’ Dupont adds.

At KBC, we offer several solutions for responsible investing, to enable investors to help make a difference. Responsible bonds undoubtedly deserve a place among these solutions.
‘What sets us apart is the strategic vision with which KBC navigates through the universe of socially responsible bonds,’ Dupont and Goeminne concur.  ‘Our strategists, economists and bond experts bring together their knowledge and expertise. This method enables us to develop a substantiated vision for different bond types, maturities, regions and sectors, and even individual names, which we then use as a basis for our investment decisions.’ 

Investing involves risks. The value of an investment depends on movements in the financial markets and can go down as well as up. Investors may not get their original deposit back in full. Past performance offers no guarantee and is not always a reliable indicator of future results.