Fiscal spending: the green dividend?

Key points:

• Governments are likely to boost fiscal spending in 2020
• Climate change initiatives are likely to be one of the areas targeted by governments 
• As sustainable investing grows in popularity, will green bonds attract more converts?
• Can green bonds make investment sense too?

After several years of increasingly accommodative monetary policy, increased fiscal stimulus is likely to be a more prominent investment theme in 2020. Such a move even forms part of this year’s US election campaign, with the Democrat party announcing a $760bn infrastructure plan.

Additional government spending aimed at tackling the threat of the coronavirus outbreak is one area where commitments are already being seen. But stimulus measures targeted at addressing commitments to tackle climate change are set to be far more important in the long term.

As governments try to demonstrate their green credentials, similarly, many companies and investors are also paying more attention to climate change when making decisions. The increasing popularity of green bonds is a case in point.

The green bond principles, issued by the International Capital Market Association in 2018, defines green, social and sustainability bonds as one where the proceeds will be exclusively applied to eligible environmental and/or social projects. At least 95% of the proceeds must be earmarked for such projects, which is often tracked by ongoing reporting by the issuer.

Issuance of green bonds hit $260bn in 2019, up 51% from issuance levels in 2018 and only 12 years since the first green bond was launched. European green bond issuers led the way in 2019, constituting 45% of global issues, followed by Asia and North America. Issuance has also been seen recently in the Middle East and Latin America.

Increased demand for sustainable investing

Moves by the authorities to support sustainability initiatives have been seen. For instance, large commitments to sustainable finance by the European Central Bank and the European Commission have been met with stronger investor demand. With their increased emphasis on sustainability of investment strategies, private clients and family offices, sovereign wealth funds and mutual funds are likely to seek more supply of green bonds.

Combining traditional investment goals with impact goals has become an attractive proposition. That said, it can be difficult to measure the degree of the environmental or social impact that a bond makes. Investors face differing definitions and variations of impact from different issuers. More transparency would be useful.

While reasons for investing in green bonds vary, does it make sense in terms of potential investment returns? There is no evidence that green bonds deliver superior returns compared to conventional bonds yet. That said, yields or spread premium of bonds are similar to, and in some cases lower than, those of conventional bonds.

The bonds allocate funds to specific projects, though they are normally not secured against assets or revenue streams and the investor is ultimately exposed to the same credit risk as holders of conventional bonds. The marginally lower yield of green bonds results from the extra demand from dedicated responsible mandates and limited choice of bonds.

The credit quality of green bonds relative to conventional ones is the same. However, businesses that issue green bonds often place much emphasis on governance and sustainability when defining company strategy. Such an approach should make any debt more resilient and less exposed to adverse scenarios in the long term.

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