Impact Credit Insights by Luca Manera, CFA, Investment Manager
Green Bond Market: back on track in H1’23
The first half of 2023 is surely one for the record books, with the best start ever for European equities, deeply inverted yield curves, and interest rate volatility last seen during the financial crisis. In addition, markets weathered the first banking crisis in the US since 2008 and the collapse of Credit Suisse. Despite these challenges, risk assets such as corporate credit, high yield and equities generated impressive excess returns. Notably, Apple Inc.’s market capitalization reached $3trillion and Nvidia joined the $1 trillion club, on the other hand AT1 bonds of Credit Suisse were wiped out.
Fixed income total returns were positive but volatile due to renewed hawkishness of central banks. Importantly, green bonds performed in-line with broad investment grade markets, as issuance recovered and topped Euro186bn, a 30% increase compared to the same period in 2022 and double that in 2021. Given the continued growth in green bonds and investors’ focus on investment grade, we look back at some of the developments that shaped the green bond market during the first half of the year.
Performance: Green bonds are back on track
The green bond index performed in-line with conventional aggregate indices. January performance was particularly strong given the exposure to corporate spreads and Italian BTPs, while February and March were more challenging due to the longer duration and the risk-off environment. During the second quarter, returns were largely muted with a limited impact from the sell-off in US treasuries in May. Overall for the first half, the green bond index returned 1.8% compared to 1.9% for the Euro Agg. and 1.4% for the Global Agg. index, in Euro hedged terms.
H1’23 Performance: Volatile first half, while green bonds perform in-line with aggregate indices
Source: Asteria IM, ICE Index
The green bond index has historically suffered compared to broad indices, due to the higher modified duration which was a significant driver of under-performance in 2021 and 2022. However, over the past quarters it has declined to reach 6.8, below that of the Global index, and somewhat above that of the Euro aggregate index. This has also contributed to reduce the tracking error which has come down significantly since the start of the year, back to levels last seen in 2020 and 2021.
Back on track: Falling modified duration and tracking error, more in-line with aggregate indices
Source: Asteria IM, ICE Index
Overall, green bonds are back on track, as on a year-to-date basis returns have performed in-line with broad indices, modified duration has been falling and realized tracking error has normalized, compared to the last two years.
New issuance: Record start and steady market share gains
The first six months have seen a significant amount of issuance which amounted to Euro186bn, of which 88bn during the first quarter and 98bn in the second quarter. This is a significant increase compared to Euro147bn and 93bn for the first half of 2022 and 2021, respectively. As a result, it comes as no surprise that green bonds are increasingly growing in terms of market share, especially in Europe where they account for over 6% of the investment grade market.
Record start for global green bond sales and Euro-denominated green bonds account for 6% of the IG debt stack
Source: Asteria IM, ICE Index
In more detail, sovereign and quasi-agency bonds made up for 60% of global issuance, followed by financials (18%), industrials (12%) and utilities (11%). From a rating perspective, AAA-rated issuance accounted for 37%, followed by BBBs (29%), single-A (23%) and double-A (11%). The overwhelming majority of issuance was Euro denominated, however USD green bond issuance reached $48bn, which ranks among the best six-month period ever, albeit it remains marginal compared to the size of the US investment grade market.
The green bond market continues to benefit from the strong issuance momentum, with an increasing number of issuers, bonds and diversification across currencies, ratings and sectors.
Performers, laggards and movers
Given the volatility during the first half, the green bond market has seen its fair share of performers, laggards and movers. In particular, the best performing hard-currency bonds include the euro denominated CTP NV 1.5% due 2031 which returned over 17% and TenneT 1.125% due 2041 returning 15.4%, while on a relative contribution basis Italian Green BTPs were the single largest contributor accounting for 0.16% of the total return and with an average of 7.8%.
On the other hand, laggards include the USD-denominated Hudson Pacific Properties 5.95% due 2028 falling -11.9%, followed by the UK green gilt due 2053 returning -7.7%, along with Berlin Hyp 1.5% due 2028 falling by -3.4%. As a result, the UK Gilts accounted for the largest detractor to index performance, as yields soared due to the rising inflation in the UK.
There have been several new inaugural green bond issues, such as those of India, Israel, Stellantis and Siemens Energy (which then announced a profit warning due to the impact of its Siemens Gamesa acquisition). From an M&A perspective, TenneT, the part-Dutch and German owned transmission system operator, has (again) been involved in discussions to sell its German operations to the German government, delivering on one of the best excess returns in the index. Also, Credit Suisse’s green bond due 2025 (senior unsecured) dropped about 10points to then bounce back just a couple of days later. Finally, Italy issued the single largest green bond with a face value of Euro10 billion.
Bond returns to focus on growth, as hiking cycle peaks
Overall, bonds have generated positive returns for the first six months, albeit with significant volatility, driven by strong excess returns as the economy continued to surprise to the upside. In this market environment, green bonds continued to perform in terms of issuance, but most importantly delivering returns more aligned with aggregate indices, compared to the past years. Investment grade bond performance, whether green or not, remains firmly driven by the economic outlook as the hiking cycle comes to an end and investors move their focus on the strength (or weakness) in economic growth and the impact from higher interest rates.