Updated with correction
Money managers, institutional investors and others are combining efforts to drive the nascent green bonds market forward, and the fruits of their labor are becoming apparent.
Several new institutional strategies being developed that include green bonds could launch later this year, according to several sources. Recent government initiatives around the world promise to add liquidity to a relatively tiny market estimated at $3.5 billion to $5 billion. Furthermore, industry standards are being proposed to attract more institutional investors, who have remained aloof so far, with a few notable exceptions.
The definition of green bonds varies widely, but in general they are issued to raise capital to fund specific projects aimed at reducing climate change risk. So far, most programs are dedicated to infrastructure improvements, either globally or within the country in which the bonds are issued.
Because of its relative new existence, managers generally have not used green bonds in their portfolios. However, the ability for such fixed-income instruments to provide attractive returns at relatively low risk in addition to diversification characteristics and potential to tap into emerging markets growth helped heighten interest among managers such as State Street Global Advisors and Calvert Investments.
Nikko Asset Management was the first to offer an institutional strategy investing mostly in green bonds in February 2010. The strategy has about £400 million ($650 million) in assets across two funds. Nikko's Luxembourg-domiciled World Bank green bonds fund returned 11.6% in its first year, outperforming its benchmark by 190 basis points (283 basis points in U.S. dollar terms).
“The beauty of World Bank green bonds lies in their simplicity,” according to Stuart Kinnersley, CIO of Nikko Asset Management Europe Ltd., based in London. “They are uncomplicated fixed-income securities, traded in the same way as conventional bonds and backed by a (AAA-rated) supranational.”
Some large pension funds have directly invested in green bonds, but their exposure has been minimal. The funds include the $150.1 billion California State Teachers' Retirement System; the $140.6 billion New York State Common Retirement Fund; the $41.4 billion United Nations Joint Staff Pension Fund; the 222 billion Swedish kronor ($35 billion) AP Fonden 2; and the 220.8 billion kroner AP Fonden 3. In all cases, the green bonds allocation is likely less than 1% of each fund's entire fixed-income portfolio, sources said.
At Stockholm-based AP3, executives initially began investing in green bonds issued by The World Bank in 2008 and have been gradually building the portfolio since. The green bonds strategy, which includes securities denominated in kronor and U.S. dollars, totals about 840 million kronor. In comparison, the fund's entire fixed-income allocation stood around 75 billion kronor at the end of 2010. AP3 is required under Swedish law to invest at least 30% of its portfolio in fixed income.
“We consider the risk/return characteristics of the green bonds (issued by The World Bank) to be quite safe, with the potential for better performance compared to some other government bonds,” said Christina Kusoffsky Hillesoy, head of communications and sustainable investments at AP3.
Managers, such as SSgA, Boston, are exploring the possibility of offering green bond strategies. Chris McKnett, vice president and head of environmental, social and governance investing at SSgA, said green bonds are “an interesting application of sustainability in fixed income.”
“We think it's an area that's poised to grow considerably,” Mr. McKnett added. “We're doing our homework and testing demand.”
He characterized investors as being “intrigued, but are largely taking a "wait and see' attitude.”