Sustainable bonds and funds take a hit during market volatility

Although the long-term prospects look promising, soaring inflation and market volatility is taking its toll on the sustainable bond market.

As a result, the issuance of sustainable bonds is expected to remain flat this year, according to a new report from Moody’s Investors Service.

The rating agency said that global issuance declined in the first quarter of 2022, as market headwinds – including the Russian invasion of Ukraine, rising inflation, and tightening monetary policy – intensified.

It noted that issuance of green, social, sustainability and sustainability-linked bonds totalled $203 billion in the first quarter, down by 11% from the fourth quarter of 2021, and 28% from the first quarter last year.

“While our baseline expectation is that sustainable bond issuance growth will resume when market volatility abates, broader market conditions will provide greater than anticipated headwinds for sustainable bond issuance this year,” the report said.

For the full year, sustainable bond issuance is now projected to total about $1 trillion, which would be more or less the same as last year.

Breaking it down, this translated into $550 billion of green bond issuance, $125 billion of social bonds, $175 billion of sustainability bonds, and $150 billion in sustainability-linked bonds.

The main differences between the different categories are that green bonds are committed to environmental or climate projects, such as investing in renewable energy while social bonds target social impact projects, such as investing in low-cost housing for people with restricted access to the housing market.

Sustainability bonds look at a mix of social and green impact projects. which may also be aligned with the UN Sustainable Development Goals (SDGs).

Longer term, Moody’s expects growth to eventually resume. “The need for climate mitigation and adaptation financing, accelerated decarbonisation efforts to achieve net zero goals, growing regulatory attention on sustainability and a continued focus on the interconnectedness of environmental and social objectives will all support the sustainable debt markets over the long term,” it said.

Alongside climate-related issues, Moody’s noted that sustainable debt markets are increasingly financing projects to promote gender equity as well.

It added, “Global gender inequality comes at the expense of global GDP with estimated losses of US$160 trillion in human capital wealth due to disparities in earnings between men and women. There is increasing demand from investors seeking to remedy these challenges to finance projects that provide services to help bridge the gender divide.”

Overall, the global sustainable fund world took a hit in the wake of market uncertainty although a report from Morningstar shows that they proved more resilient than its conventional counterparts.

The data provider said, “As demonstrated in the past, as well as in 2020 at the start of the Covid-19 pandemic and once again in the first quarter of 2022, sustainable fund flows seem to be more resilient in times of market volatility than their traditional peers,” according to Morningstar’s research.

Its analysis showed that inflows of sustainable funds slid 36% – the sharpest quarterly slowdown in sustainable fund net inflows over the past three years.

However, the broader market experienced a 73% drop from $517bn in the final quarter of last year to $138bn in Q1.

Fund launches in the sustainable world also waned with an estimated 227 new products brought to market globally, a 28% decline compared with the 316 new entrants in Q4 2021.

Morningstar noted that Q1 launches have historically been lower, and it is likely the figure will be restated in future reports as more launches are identified. In addition, groups continued to repurpose existing funds into sustainable mandates, albeit at a slower pace.

On a regional level, Europe continued to dominate the global sustainable fund landscape with 82% of sustainable fund assets held on the continent, “which also remains by far the most developed and diverse ESG market,” said Morningstar.

The region attracted shy of $78bn in net flows, a 37% drop on Q4’s $124bn of new money. Again, this was less than the overall market, where conventional funds saw $21bn in outflows.

“As demonstrated in the past, as well as in 2020 at the start of the Covid-19 pandemic and once again in the first quarter of 2022, sustainable fund flows seem to be more resilient in times of market volatility than their traditional peers,” said the report.

As for the US, it is the second largest market for sustainable funds, accounting for 12% of global sustainable fund assets through March 2022.

However, during Q1, net flows into the country’s sustainable funds posted their fourth consecutive decline, falling $10bn.

“That is 26% less than in the previous quarter and half of the all-time record, nearly $22bn, set one year ago in the first quarter of 2021,” the update said.

However, as Morningstar noted, when compared with the broader US funds market, demand for sustainable offerings showed higher resilience during the first quarter of 2022, where flows dipped by 65% to $85.7bn affecting both active and passive strategies alike.

Morningstar said, “In recent years, investor preference has shifted towards low-cost passive funds: over the past three years, passive strategies have attracted about two thirds of quarterly sustainable fund flows on average. However, the split last quarter was close to 50-50, with passive funds netting $5.7bn for the period.”

©Markets Media Europe 2022
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