Allocating to Green Bonds

Abstract

Green bonds are about a decade old financial instrument with cash flows earmarked to improve the environment or combat climate change. We show the spectacular growth of the asset class over time, but note that it is currently still less than 1% of the entire fixed income market. The composition of the asset class has changed considerably over time. At the start, it were mainly very safe supranational institutions issuing in a variety of currencies with relatively short maturities. They were followed by corporates, especially utilities, and more recently also governments have started issuing green bonds. This change of composition leads us to conclude that historical data from before 2015 is less representative for the future. Our returns- and characteristics-based analyses show that an investor allocating to green bonds should finance this from an aggregate fixed income allocation to reduce the impact on the risk and return characteristics of the existing portfolio.

Keywords: Asset allocation, Bonds, Climate change, Environmental Social and Governance (ESG), Fixed income, Green bonds, Portfolio management, Socially Responsible Investing (SRI), Sustainable investing

JEL Classification: G11, G12, G14