Investing in ESG bonds is now a top priority for many asset managers. Asset owners are now decisively putting their weight behind responsible investment and demanding that their capital be allocated to back companies and projects with green credentials. Investment managers and other institutions have responded to this need and have set principles and standards under the umbrella of UNPRI (United Nations Principles for Responsible Investment), which counts more than 7,000 signatories, making it the world's largest voluntary corporate sustainability initiative. ICMA has also published it’s own Green Bond Principles.
The supply of new ESG bonds is increasing at an accelerated rate with $1 trillion expected to come to the market in 2021 and an expectation to hit the $2 trillion mark by 2023. In the bond market, the seismic shift in the allocation of capital towards ESG eligible debt has caused an imbalance between the supply and demand for Green bonds which has led to the so-called greenium, a premium commanded by green bonds. Asset managers are therefore faced by the challenge to balance returns and ESG compliance.
Portfolio managers are looking to transform the profile of their portfolios and need to find ways to swap existing positions for ESG ones. On one hand, they need to make their own assessment in order to decide whether the use of proceeds for a particular bond justifies its “green” identity. Analytics play an important role in the research space of ESG, and Sustainalytics pulls together many relevant data points and provides useful analytics. On the other hand, asset managers need to identify the right timing to swap into ESG bonds. An approach that can help them solve this puzzle is to find short-lived dislocations to swap out of conventional bonds held in portfolio when they are expensive and into ESG bonds at an attractive price either in the primary or secondary market. This requires the ability to monitor therelative value of positions against the universe of green bonds in the market systematically to find the right entry point.
Katana is designed to solve the problem of identifying short-lived pockets of dislocation in the fixed income market as soon as they appear and is the perfect tool to use in the ESG case. The technology leverages big data and machine learning to make millions of comparisons every day and identify market inefficiencies. Setting a list of ESG bonds as the bonds to buy, or using the newly released ESG filters, and the list of holdings as the list to sell is all a user needs to do to get all the attractive possible swaps when they emerge.
Looking at the secondary Euro-denominated investment grade corporate bond market in 2021, Katana identified more than 8,000 dislocations swapping out a conventional bond and into an ESG bond within the same industry and with very similar risk and maturity profile. This accounts for 10% of all risk-neutral Katana ideas in this period. According to our data, investors can expect similar returns by swapping a conventional bond for either ESG or another conventional one. The average spread difference for swapping a conventional bond to an ESG is 22.6bps compared to 23.8bps for swapping a conventional bond for another conventional bond. During May there has been a surge of dislocations favoring to swap from a conventional to an ESG bond, with a new increase at the beginning of July.
In the first 6 months of 2021, more ESG-related bonds were issued than in all of 2020. Investors continue to face an ever increasing universe of bonds and more options of ESG bonds to invest. Incorporating the ESG dimension in the research and investment decision process is now critical and requires tools that can help investment managers deep-dive into the data and get the necessary insights. This will be crucial as the paradigm shifts and the ESG bond universe expands.
More Resources About Fixed Income ESG Investing and Non Green / Green Bonds Bond Pricing Differentials