The first ever green gilt was recently issued by the UK government and was met with strong investor demand. While this is clearly a welcome development, green bonds alone are not an optimal solution for investors looking for both attractive risk-adjusted returns and a positive sustainable impact.
The UK ‘s inaugural green gilt issue was a 0.875% coupon-paying security maturing in 2033. The proceeds will be allocated towards eligible green expenditures, such as zero-emission buses and offshore wind power, in accordance with the UK Government Green Financing Framework.
There was very strong demand for the issue from both dedicated green investors as well as others, with order books in excess of £100bn (an all-time high for Gilts and the global green market) for a £10bn issue.
The bond came with little-to-no ‘greenium’ - the premium, or lower yield, associated with green bonds relative to conventional bonds of similar characteristics, given the additional demand for green bonds.
For us, fair value (ex any ‘greenium’) was taking the existing conventional gilt maturing in 2032, plus 7-8 basis points (bps) in yield reflecting the slightly longer maturity, and the bond priced at 7.5bps in additional yield.
This bond will enter traditional gilt-based indices (such as FTSE and iBoxx) and will be eligible for quantitative easing, similar to regular gilts. We expect green gilts to trade inside conventional gilts given the stronger demand, and the more buy and hold mentality of the investor base, who may be buying for green reasons rather than looking purely for tactical duration plays.
We welcome the news of the UK’s first green gilt but do caution investors that green bonds are not sufficient alone to meet the dual needs and wants of investors to have a combination of attractive risk-adjusted returns and positive sustainable impact.
Green bonds, by their design, finance specific projects or activities that promote environmental (or social) investment - which is very positive and, indeed, we are holders of green bonds in our sustainable and conventional bond funds. However, in our desire to create sustainable solutions, while we considered the green bond market, we concluded that an investment in green bonds alone is not enough to fulfil clients’ needs, as it is still a relatively small universe, with reduced liquidity and lack of standardisation in terms of definitions and impact measurement.
Germany issued their first ever green government bond in September 2020. It was issued alongside conventional government bonds, with a provision that investors can swap the green bond for their ‘paired’ conventional counterpart to alleviate any liquidity concerns associated with the former. This certainly goes some way in supporting some of our concerns of using green bonds as a sole solution.
Investors also need to factor in that green bonds tend to trade at a ‘greenium’ despite having the same inherent credit risk too. For example, the green German government bond now trades with a yield that is 6 bps less than its conventional twin, which confirms that investors need to pay to bolster their green credentials. We see this in the corporate bond space too, where green bonds issued by the same issuer can offer anywhere up to 20% less in yield terms relative to their conventional bond counterparts.
Sustainability considerations are increasingly becoming important drivers of fixed income markets. Highly complex and multi-faceted issues like the carbon crisis cannot be solved with simple solutions like buying green bonds alone, and while we applaud the financial innovation, it is important that investors cast their net beyond green bonds to both capture opportunities and positively influence change in sustainability practices.
About the authors
Sajiv Vaid, Fund Manager, Fidelity International
Sajiv has over 22 years of investment experience. He joined Fidelity from Royal London Asset Management in 2015. He is co-manager of the Fidelity MoneyBuilder Income, Short-dated Corporate Bond and Extra Income Funds.
Kris Atkinson, Portfolio Manager, Fidelity International
Kris joined Fidelity in 2000 and has been co-manager of the Fidelity MoneyBuilder Income and Fidelity Short Dated Corporate Bond Funds since January 2019.
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