5 ways green investments could power a sustainable COVID-19 recovery

In addition to healthcare inequality, the COVID-19 pandemic also helped underscore the importance of social justice and creating a livable and sustainable environment in diverse communities. As a result, some non-profits, governments, companies and investors hope to address these issues as part of a broad economic reopening and an effort to build long-term resilience to large-scale risks. Bonds tied to sustainability projects could play an important role in making this happen.

Already in 2020, issuers and investment allocators alike showed growing appetite for fixed income funding to help address environmental and social issues. Green bonds, social bonds and sustainability bonds raised more than $600 billion from investors, nearly double the $326 billion issued in 2019.1 Demand grew for social bonds and sustainability bonds, in particular, as the public and private sector prioritized projects to address issues exacerbated by the pandemic, such as decreased nonprofit funding, falling health-care system revenues and unequal access to resources and opportunities.

That increased demand for sustainable investing through environmental and socially oriented bonds is poised to remain steady this year, driven by five global and regional trends:

1. Rising social awareness of sustainability

The uneven impact of COVID-19 on diverse communities spurred greater awareness of social issues, and how they affect economic outcomes, a realization that will likely persist among investors and asset owners. Indeed, social bond issuance grew exponentially in 2020, representing more than a quarter of total labelled sustainable bond offerings globally.2 While spurred in part by the rise in pandemic-response bonds, a breadth of other types of projects earmarked for social causes also increased.

Rising social-mindedness may become an established feature of the fixed income market. In a post-pandemic world, customers, employees and investors are increasingly scrutinizing companies' behavior and future viability, with respect to the communities in which they operate, their supply chains and workforces and the accessibility and affordability of their services and products.

2. Sustainability-linked bonds accelerating globally

Since their advent to the market in the late 2000s, and early 2010s for corporates, “use of proceeds” green or social bonds have become investors’ debt instrument of choice in supporting sustainability. Some investors, however, have begun to question the quality of the projects, commitments or outcomes they’re funding. Is capital flowing merely to one-off corporate disbursements, or is it supporting an overall business strategy focused on green or social goals? For example, green bonds issued for environmental projects by a company with a business model that fundamentally ignores sustainability, may meet with investor skepticism. Another investor concern: some green and social bond issuers seem to risk nothing—beyond their reputations—because the bond terms lack any penalties for failure to follow through on proposed projects.

These types of concerns, along with challenges for corporates that have less capex-intensive business models to find sufficient volumes of eligible green or social projects, have given rise to sustainability-linked bonds, which define a higher interest rate owed to investors if issuers don’t meet agreed-upon sustainability performance targets. After a relatively slow start from their introduction in September 2019, this new type of bonds has been gaining significant traction, with more than $20 billion issued at the end of March 2021,3 and new issuance in the first quarter already more than 90% of the total amount issued in the whole of 2020.

The publication, in June 2020, of the Sustainability-Linked Bond Principles by the International Capital Market Association, which lays out guidelines for structuring features, disclosure and reporting for this new class of bonds, has contributed to this rapid growth, and is likely to continue fueling a significant increase in issuance of sustainability-linked bonds, as companies consider new paths to capital-market fundraising.

3. Central banks mulling sustainable bond purchases

Market participants have speculated about whether central banks, particularly the European Central Bank (ECB) might incorporate environmental considerations into its bond-buying program known as “quantitative easing” in determining how to inject money into the post-pandemic economy to bolster growth. The ECB already announced plans to stress-test banks on climate risks,4 so it’s entirely plausible that it could apply the same lens to its own balance sheet. What’s more, ECB Executive Board Member Isabel Schnabel, reflecting on the central bank’s bond-purchase program, observed that the Bank could consider excluding from its program certain bonds used to finance projects that conflict with the EU’s decarbonization objectives.5

Sweden’s Riksbank set a similar precedent by starting, from January 2021, to offer to purchase only bonds issued by companies it deems in compliance with international standards and norms for sustainability.6 If the ECB takes a similar course of action, investors would need to reevaluate the implications for credit risk premia, or how the return of higher-risk bonds that do not meet sustainability criteria would compare with the return of lower-risk bonds that do.

4. Sustainable bonds catching on in the U.S.

Global sustainable bond issuance increased significantly in the past year, but U.S. issuers accounted for little of that growth, making up just about 20% of total corporate sustainable bond issuance in 2020.7 Yet investor demand for sustainable investing solutions is growing faster in the U.S. than anywhere else in the world. That means 2021 could become a turning point for U.S. corporate issuers of sustainable bonds, as they raise capital to rebuild their industries.

The pro-environmental tone of the Biden administration’s efforts—and some if its immediate actions, such as rejoining the Paris Agreement—could provide a supportive backdrop for corporate America to consider its contribution to global sustainability goals, as part of the broader economic recovery.

5. Sustainability growing in the U.S. Munibond Market

Sustainability-focused bonds may also gain traction in the U.S. municipal bond market this year. U.S. cities have a long history of investing in projects with positive environmental or social benefits, but the share of the U.S. munibond market tied to sustainability principles, while growing steadily in recent years, is still quite small.

In 2016, only 2.6% of total U.S. munibonds issued were tied to ESG principles. In 2020, that share grew to 6.7%, as some state and local governments, such as cities, counties or related agencies, accessed much needed capital to fund critical needs, ranging from paying employees to improving water quality. We see plenty of room for additional growth. Indeed, sustainable municipal bond issuance in 2021 could reach $30 billion, almost triple the issuance in 2019, according to S&P Global Ratings.

Risk considerations

There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and that the value of Portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. ESG strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.