The official blog of BNP Paribas Asset Management

How to allocate capital to green bonds? (3/3)

If green bonds are not a distinct asset class, how can investors include them in their capital allocation decisions? In the final article of this three-part series, we raise two broad options (but there is likely an indefinite number in reality).

  • Going for just green bonds?
  • Or adding them to a general bond portfolio?
  • For maximum impact, go for maximum green

Allocating capital to green bonds – option 1

If an investor is truly looking to finance green activities, a deliberate approach would be to set up a dedicated green bond fund. The risk-return characteristics of such a fund should hypothetically be equivalent to those of a non-green bond fund with the same fund characteristics (e.g. equal percentage of the assets invested in AAA rated bonds, equal-weighted average duration).

In reality, though, we can expect differences in volatility, yields, drawdowns, etc., given that not all issuers have green bond equivalents of their existing bonds. However, there are also the environmental benefits (enjoyed by society) from those green bonds on top of the materially equivalent yields from an equivalent non-green bond fund, at no material (extra) cost to the investor.

Allocating capital to green bonds – option 2

Alternatively, an investor could take an opportunistic approach to their regular bond fund and tilt their preferences to green bonds whenever possible, but without the constraint to invest in green bonds only.

Over time, this fund can become greener as the supply of green bonds scales up, but the fund does not need a deliberate objective to do so. Such a fund can pursue return objectives unconstrained by the supply of green bonds, yet choose to allocate capital to green activities at no material (extra) cost when there is a good opportunity.

Critics can argue that for the first option, the money can simply be invested in an unconstrained bond fund that seeks even higher-yielding bonds outside of the universe of green bonds. That is true, but higher-yielding bonds also mean higher financial risk. If an investor does not want a higher-yielding (risk) fund, and goes for a fund whose risk profile that can be matched by a green bond fund, then why not go for the green bond fund that has environmental benefits at no material (extra) cost to the investor?

Essentially, this is how investors shop for bond funds today. An asset manager proposes a fund with investment objectives and risk management constraints. If the investor likes it, they put their money into the fund. If not, the asset manager tailors the fund to meet the investor’s needs.

Choosing between the options

For an investor looking to invest in green bonds, the first question concerns the yields and financial risks they are expecting to carry. Can this be taken care of through a dedicated green bond fund with a materially equivalent yield and risk objectives? Does the investor want to finance green activities through that fund? If not, the investor can go with option two – an opportunistic approach.

Go for green – it is better

From an asset allocation perspective, green bonds should be considered as regular bonds within the same framework for deciding how much of a portfolio should be allocated to bonds (considering the yields and risks).

Once an allocation is made to bonds as an asset class, the investor can consider using a dedicated green bond fund approach, or an opportunistic regular bond fund approach. Of course, from the perspective of environmental benefit, a dedicated fund can achieve much more than an opportunistic approach. Still, at least both approaches can generate environmental benefits, and since we are facing a climate emergency, we need every contribution we can get.

Also read:

Should green bonds be considered an asset class? What is an asset class? (1/3)

Do 'greeniums' make green bonds into an asset class? (2/3)

To discover our funds and select the ones that meet your requirements, click here >

For morte articles by Xuan Sheng Ou Yong, click here >

For more articles on sustainable investing, click here >

For more about sustainability at BNP Paribas Asset Management, click here >

Global Sustainability Strategy - sustainable investment SRI - sustainable investing

Discover the sustainable investment solutions of BNP Paribas Asset Management and read more about what sustainability means to us.

Read more about our Global Sustainability Strategy

Investors Corner app

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related articles

Weekly insights, straight to your inbox

A round-up of this week's key economic and market trends, and insights on what to expect going forward.

Please enter a valid email
Please check the boxes below to subscribe