Green Bonds, Sustainability Linked bonds and Valuation

By Marie Lassegnore, Credit Portfolio Manager & ESG Director for Fixed Income and Cross Asset, La Française AM.

Over the last few years, we have seen an increase in assets invested in ESG fixed income funds. This can be explained by two reasons:

• 1.Investors' desire to invest responsibly.
• 2. Regulators' incentives to include ESG criteria in savings and investment products.

Historically, green finance has been channeled through green or impact bonds, as these bonds identify, select and report on specific projects and the impact of the funding that goes to these investments.

In response to the pandemic, the EU has used the social bond format for its SURE program (Support to mitigate Unemployment Risks in an Emergency) which has supported the growth of the impact bond market in 2020.

This market continues to grow and is now over USD 1trn in size. The sectoral diversification of this market has improved as we have seen the emergence of new types of instruments such as Sustainability Linked Bonds (SLBs).  These bonds do not focus on the use of proceeds raised at issuance, but rather on the achievement of the ESG objectives set at the global corporate level by the issuer. This development has enabled more sectors, structurally carbon intensive, to come to the “ESG” Bonds market. La Française expects this trend to continue, as the ECB also allows these instruments (SLBs) to be eligible as collateral in the Asset Purchase Program (APP) and the Pandemic Emergency Purchase Program (PEPP) as long as the objective of the project is linked to the environment and in line with the objectives of the European taxonomy.

Valuations:

The distortion between the limited depth of the green bond market and increased investor demand has led to the creation of an apparent valuation premium, which we call "Greenium". Basically, when looking at green versus traditional indices, we could speak of a structural greenium of 4/5 basis points on average.

Source: Bloomberg, La Francaise, data as at 31/01/2021

However, when comparing "like for like", i.e. comparable yields of the same issuers with bonds of the same maturity "green" versus "non-green", no systematic statistical outperformance can be determined:

Source: Goldman Sachs, data as of 09/02/2021

Therefore, as we cannot generalize, we have to perform an individual analysis issuer by issuer, curve by curve. For example, the ENEL senior EUR curve below shows that a ‘greenium’ is only really visible in the longest maturity green bond. The reason behind this contraction lies in the context: in 2020, with falling rates, investors have shifted massively to longer maturities and therefore this green bond reflects a narrower spread. It should be noted that in the green bond universe there is a shortage of bonds with very long maturities and therefore the bonds with higher duration have benefited from this narrowing in recent times.

This graph also shows that the SLBs ENEL has issued so far are valued in line with the traditional bonds as it reflects the credit risk of the issuer. One must keep in mind that the SLB market is still very ‘young’ so no homogeneous conclusions with regards to pricing can be drawn at this stage.

Source: Bloomberg, La Francaise data as at 31/01/2021

What this chart does not show is what will happen when the SLBs reach maturity. Depending on whether or not the issuer meets its climate commitments, it could pay a lower or higher coupon as the coupon includes a "step up or down" at maturity if the issuer succeeds or fails to meet its ESG targets.

Consistency between SLBs and La Française's Carbon Impact approach:

In the graph below you can see an illustration of how concretely Green and SLBs issuance are part of the bigger picture we are aiming to capture through our Carbon Impact approach.

We see several projects financed by green bonds with identified assets which help the company reduce its emissions in the long term. On the other hand, we see that the multiplication of green projects has the same result as the SLB’s objective (in blue), which would have the vocation, over a period of 10 years or more, to reduce the company's carbon emissions. This SLB approach is similar to what La Française implements in the Carbon Impact portfolios, as we calculate the confidence corridor of each company's emissions reduction targets in the medium and long term. At La Francaise we ensure that these targets or projects are achieved and that they are ambitious enough to achieve the 2DS target or below 2DS.

 Source: La Française AM, data as at 31/01/2021

Disclaimer

The objective of the carbon impact strategy is to achieve a net return which is greater than the performance of the French government's euro bonds maturing in 2026, by investing in a portfolio of issuers analyzed with regard to their compatibility with the energy transition.

Primary risks associated with the carbon impact strategy include: risk of capital loss, interest rate risk, credit risk, default risk relating to issuers of debt securities, risks associated with investments in high yield securities known as speculative securities.

PROMOTIONAL DOCUMENT. THIS DOCUMENT IS INTENDED FOR PROFESSIONAL INVESTORS WITHIN THE MEANING OFMiFID II ONLY.

The information contained in this document in no way constitutes an offer or solicitation to invest, nor does it constitute investment advice or a recommendation on specific investments. The information, opinions and numerical data are considered to be well-founded or accurate on the date when they were drawn up in the light of the economic, financial and stock market climate at that time. They reflect the opinion of La Française Group regarding the markets and their trends on the date in question. They have no contractual value, are subject to change and may differ from other management companies. Performance is not constant over time. Past performance is no indication of current or future performance. Issued by La Française AM Finance Services, whose head office is located at 128 boulevard Raspail, 75006 Paris, France. It is regulated by the "Autorité de Contrôle Prudentiel" as an investment services provider under number 18673 X, an affiliate of La Française. Website information: Autorité de Contrôle Prudentiel et de Résolution www.acpr.banque-france.fr, Autorité des Marchés Financiers www.amf-france.org

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