Fixed income is lagging behind equity when it comes to environmental, social, and governance (ESG) product development. However, the pace of sustainable product launches in the fixed-income space in Europe is set to accelerate, with COVID-19 being a key catalyst, according to the latest issue of The Cerulli Edge―Europe Edition.

The EU has committed almost €550 billion (US$667 billion) to green projects over the next seven years. Some €225 billion worth of green bonds will be issued to help finance the projects—part of the union’s €750 billion of borrowing earmarked for its coronavirus recovery fund, says Justina Deveikyte, director, European institutional research, at Cerulli Associates.

Opinions vary as to the potential speed of EU green bond issuance, but, given that green project financing is being touted as a driver of the economic recovery, Cerulli expects issuance to occur sooner rather than later. However, it will be dependent on a pipeline of suitable green infrastructure projects.

Green bond issuance in Europe has been rising. Just €19 billion of green bonds were issued in Europe in 2015, compared to €117 billion in 2019, according to the Climate Bonds Initiative (CBI), an international, investor-focused nonprofit. At the end of 2019, the European green bond market stood at €318 billion and the global green bond market at €776 billion. As issuance has grown, so too has the number of green bond funds. In 2019, seven green bond funds were brought to market, the largest number of green bond funds ever to be launched in a single year.

Although EU green bond issuance has the potential to be the biggest driver of the European green bond market, corporate issuance has been rising. According to the CBI, the value of green bonds issued by non-corporates (government-backed entities, local government, sovereigns, and development banks) grew by 61.9% annually between 2015 and 2019, representing 55.2% of all new issues. However, financial and non-financial corporate issuers have been the biggest source of green bonds in every quarter since 3Q 2018.

“Given that the green bond fund market is relatively immature and significant growth in assets under management is expected, there is considerable scope for fund houses new to the space,” says Deveikyte. “At present, there are just 42 Europe-domiciled green bond funds available to investors, managed by 36 different asset managers. A significant issuance of green bond assets will support the construction of new funds. With relatively low barriers to entry, managers not active in this space should consider entry.”

Other Findings:

• The resilience of fixed-income exchange-traded funds (ETFs) in the spring of 2020 may prove to be pivotal in the development of the market for such products in Europe. Net inflows into Europe-listed fixed-income ETFs hit US$41 billion in 2020, despite the March turmoil. A chief driver of demand from both institutional and retail investors is the role that bond ETFs play in maintaining diversification, says Cerulli. It notes that one of the patterns to emerge in 2020 was a shift from single-bond portfolios to both sovereign and corporate bond ETFs.

• Yields on developed market sovereign bonds look set to remain low for some time, but the March 2020 drawdown once more underlined the value of diversification against equity risk when constructing a portfolio. However, regular reassessment and balancing of income and portfolio protection objectives is vital when seeking to minimize divergence from the target liquidity, risk, cost, income, and alpha generation of each portfolio.