Green bonds duration risk review

8 minute read

In this note, we analyse the interest-rate sensitivity of the bigger euro-denominated green bond funds as a proxy for the whole asset class.

There has been solid growth in both fund launches and AUMs. One can suspect that the duration risk could be substantial in this space, as the growth in AUM has come during a bullish rates environment, where bond issuers have been able to extend across the curve.

With recent rises in interest rates, with both US and German 10-year yields moving up by around 50bps between early August and early November, investors across all asset classes are assessing their sensitivity to rates.

For climate focused fixed income investors, a natural question is how green bonds behave in this new territory. Since the real inception of the green bond market in 2013, euro rates have rarely been put on an upward trajectory. Our analysis finds that Green Bond Funds (GBF) total returns have high rates correlation, especially with the long end of the rates curve. The implication of this is that total return investors allocating into green bonds should indeed keep a close eye on what interest rate exposure they want in their green bond portfolios.

Also, green bond issuers tend to be low-spread names, further increasing duration exposure. Not surprisingly, our analysis finds that Green Bond Funds (GBF) total returns have high rates correlation, especially with the long end of the rates curve.

The implication of this is that total return investors allocating into green bonds should indeed keep a close eye on what interest rate exposure they want in their green bond portfolio. With new sovereign issuers coming to the market, one could expect GBFs’ total returns to increase even more in correlation with the underlying sovereign duration-based returns.

However, when looking at the changing composition of the GB universe, we see increasing sovereign issuances being matched by more corporates, and a shrinking SSA relative issuance. This issuance ‘barbell’ may actually be neutral for GBFs’ exposure to interest rate rather than credit risks.