Quantitative research

Transition linkers

Written by Ulf Erlandsson

This paper introduces a new type of a bond, a transition linker, which allows investors to hedge risky asset return correlation with national energy transition progression. 

Sharing features with inflation linkers, convertibles and other performance-linked bonds, the transition linker is a sovereign bond where the coupon level adjusts in several steps if the issuer under- or outperforms vis-à-vis externally committed transition decarbonisation targets. 

We show how the transition linker can be useful in asset allocation with the investment hypothesis that risky asset returns will be lower and/or more volatile in case of an unsuccessful transition. At the same time, the linker provides cost-of-capital incentives for the issuer (the government) to generate policies that increase the transition likelihood.

The linker can also be used to derive implied probabilities of reaching transition targets, providing investors, the general public and the issuers themselves important real-time information on transition progress.

The paper develops a pricing approach for transition linkers and discusses various structural implementations to accommodate traditional mainstream fixed income books.

Finally, it analyses a hypothetical transition linker format for the case of Japan, an already active sovereign issuer of inflation linked and transition bonds.

We're delighted to share that the transition linker proposal was awarded 'Best Paper' at the European Union's 8th Sustainable and Impact Investments International Conference in January 2025.

Link to article at SSRN

About the author

Ulf Erlandsson

Ulf Erlandsson

Founder, Board member

Dr Ulf Erlandsson founded the Anthropocene Fixed Income Institute and was its first CEO. A pioneer of climate-focused fixed income portfolio management, he was named Environmental Finance’s Bond Personality of the Year 2022.

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