Bonds are Back and Aligned with a Greener Future

Flows to this asset class have accelerated over the past few months (€5.7 billion YTD), supported by the positive performance of underlying exposures. Spreads have also reverted to the levels seen at the end of Q1 2022, prior to the bond market sell-off. 

^{Sources: Amundi ETF, Morningstar, data as at 14/04/2023.}

^{Past performance is not a reliable indicator of future returns.}

Fundamentals appear strong

Across Europe, the effects of higher policy rates are still feeding through to borrowing costs for businesses and households, and have already led to an erosion in lending and demand. Despite this, the impact on corporate credit, thus far, has been contained owing to limited refinancing needs and the high use of cash reserves built up over the Covid period. And although the environment for corporates will get tougher, we believe that spread levels in the European corporate bond market have priced in a far bleaker-than-materialised outcome.

Moreover, following last year’s sell-off, and a decade of low-to-negative interest rates, investment-grade corporate credit is exhibiting attractive valuations with yield levels comfortably above 4%¹. Investment-grade credit companies will be more likely to withstand a tougher environment ahead owing to strong fundamentals. Many have even been able to increase their profit margins in the face of increased production costs.

Even in the face of the recent market turmoil, investment-grade credit quality has continued to improve with rating upgrades for EUR corporates beating downgrades for a fifth consecutive quarter.

Marrying Fixed Income with the Paris Agreement

With climate change widely recognised as a clear and present threat to the planet, ever more investors are seeking to align their portfolios with the net zero goals of the Paris agreement.

So how can investors tap into the potential opportunity in Euro-denominated investment-grade credit, while pursuing a net zero strategy?

An increasingly popular route is via climate-aligned indices, which help investors to meet their climate objectives by tilting exposures towards constituents with better climate profiles.

In 2019, the European Commission unveiled two benchmarks that comply with the Paris Agreement – supporting the transition to a Net-Zero world by 2050 and limiting a global average temperature rise of 1.5°C; the Climate Transition Benchmark (CTB) and the Paris-aligned Benchmark (PAB). Major index providers, quick to recognise the opportunity, responded by launching a range of climate indices complying with these benchmarks’ requirements.

Both benchmarks focus on a decarbonisation level of at least 7% on average per year, but PAB indices aim to reduce carbon intensity by 50%, compared to the initial investment universe, versus 30% for CTB indices. PAB indices also apply some exclusion filters on companies involved in fossil fuel exploration and coal.

PAB is thus slightly stricter with regards to its thresholds, and may therefore be more suitable for investors who want to be at the forefront of the energy transition. Both benchmarks have been widely embraced by the sustainable finance community, and a growing number of asset managers and asset owners are incorporating PAB into their investment strategies.

Investment-grade credit and the net zero trajectory: Capturing the opportunity

Combining investment-grade credit with a PAB benchmark can bridge the gap between having a core credit allocation with solid fundamentals and an enhanced ESG profile: the Bloomberg MSCI EUR Corporate PAB Green Tilted Index ties it all in.

The table below shows the very limited tracking error between a PAB titled corporate bond index compared to an unfiltered investment universe. At the same time, the PAB corporate bond index allows for an improved ESG score and much lower carbon intensity. Performance is also broadly comparable.

Conclusion

Bonds are offering attractive yields once again, and in our view, the case for Euro-denominated Investment Grade Credit is currently compelling. Investors wishing to tap into this opportunity, but also respond to the climate emergency may wish to consider using a PAB approach. PAB indices help investors to implement net-zero strategies in their portfolios by tilting exposures towards constituents with better climate profiles. This can result in improved ESG scores and a far lower carbon intensity without affecting performance. By investing in ETFs aligned to a PAB benchmark, investors can be assured that their investments are benchmarked against a standard that aligns with the Paris Agreement's goals.

^1. Sources: Amundi ETF, Bloomberg, data as at 17/04/2023. Past performance is not a reliable indicator of future returns

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