Views and Analysis
Investors are increasingly looking to support global climate action
Andrew Lake, Head of Global Fixed Income, outlines why a hybrid approach between green bonds and transition bonds is the right route to drive lower carbon emissions, which is key to meeting Paris Agreement targets.
Mitigating climate impacts
Green bonds offer similar ratings, yields and return profiles that other broad fixed income sectors. The primary focus of green bonds is climate mitigation, by funding projects that make a measurable impact to address environmental challenges. We focus our investments into green bonds that fund specific projects, including renewable energy, energy efficiency and clean transportation to support a low carbon economy.
The market for green bonds is rapidly expanding, with a record US$269.5 of issuance in 2020, of which 35% was used to fund energy projects and 24% used to fund green transportation and by the end of 2021, the total size of the market was US$1 trillion. However, in the first quarter of 2021 alone, green bond issuance expanded by US$285bn across 460 issues. This growth underscores the importance of green bonds in funding low carbon environment projects.
We believe green bonds should be part of an overall climate strategy because of the important role they play on climate change mitigation. For example, green bonds that fund more sustainable methods of public transport can help move passengers out of cars, into lower carbon alternatives.
Although green bonds can fund a wide variety of environmental projects, today, they tend to be issued by utilities, large conglomerates (such as industrial companies) and financials (especially banks), and this reflects the breakdown of green bond indices, as outlined below.
However, by their very nature, in funding environmental projects, green bonds are focused on low carbon areas, which will have a limited impact in leading to a reduction in overall carbon emissions that is required to meet Paris Agreement targets. Therefore, we believe that to help influence meaningful climate change, debt should be linked to clear targets for higher carbon companies to reduce their emissions. Transition bonds have a key role to play in addressing climate change.
A balance between green and energy transition
To really tackle climate change, we believe that as investors, allocating capital to traditional bonds of higher emitting issuers that are actively seeking to reduce their carbon footprint in line with the Paris Agreement targets is key to helping lower greenhouse gas emissions over the next decade. These are transition bonds.
We also believe that transition bonds provide us with more access to investment options across a broader range of industry sectors, to drive performance and manage risk from a multi-sector credit portfolio. This is reflected in the size of the global bond market, which is US$119 trillion versus US$1 trillion for green bonds.
Furthermore, issuers in higher emitting sectors must strive for lower greenhouse gas emissions as governments push businesses to become greener as they commit to becoming carbon neutral by 2050. However, we recognise that the higher a company’s emissions, there is a greater need to transition to lower carbon activities, but this elevates the risks. This requires an active approach, rigorous analysis and a highly structured framework of engagement.
However, as higher emitting companies transition to net zero emission, this also leads to opportunities. Companies that can lower carbon emissions will extract efficiencies and become more competitive and a growing number of issuers are now making commitments to carbon neutrality.
Our hybrid approach
We take a slightly different stance to other hybrid strategies by having the flexibility to invest in fossil fuels and allocating to high yield. However, all transition bond issuers that we select must demonstrate leadership in lowering their carbon emissions.
Excluding fossil fuels does not address current carbon emissions across other high carbon emitting sectors. Over the next decade of energy transition, as we see a gradual shift away from fossil fuels to renewables, think the oil and gas majors can contribute significantly to the reduction of carbon emissions, through initiatives such as supporting the growth of deep decarbonisation technologies, such as carbon capture, storage and hydrogen, one pathway for decarbonising petroleum.
We recognise, however, that the oil and gas majors are all on different paths to lowering their carbon footprint and some are farther ahead than others. For example, in May 2020, European super-major Total adopted a new climate ambition to get to net zero by 2050.
Finally, having the flexibility to access high yield means we can maximise the longer-term return profile of a hybrid climate bond strategy, and tap into a broader range of issuers that are committed to net-zero. The arrival of former investment grade issuers into the high yield universe as a result of the pandemic also provides us with access to what we believe are still good quality companies, which do not need to refinance their debt, and which are committed to reducing their carbon emissions.
Once we select a green bond or transition bond, our work is only just starting. We have a structured framework in place for engagement and in collecting metrics. For transition bonds, our goal on engagement is to assess if they are on–track to meet net-zero emissions by 2050. We also validate how green bonds are creating impact through separate analysis from third party providers such as Sustainalytics. In short, we believe that robust engagement required, ensuring that green bond and transition bond issuers remain on the right path.
In summary, this all-inclusive approach focuses on climate mitigation through green bonds and avoids restricting our ability to support traditional issuers that we believe can drive meaningful action to reduce carbon emissions in line with the Paris Agreement. After all, reducing carbon emissions globally is crucial to managing climate change and we believe that engaging with issuers to achieve this is a key responsibility of investors like us.
 Refinitiv.com, April 2021
 Securities Industry and Financial Markets Association, 2021
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Head of Fixed Income