Sovereign Sustainability: How Duration Impacts Returns in Labeled Sovereign Bonds

Sustainable investing for sovereign bonds may come with a caveat: Green bonds tend to have longer duration profiles than non-labeled equivalents.¹

We compiled a sample basket of green bonds that exhibited characteristics of good governance, doing no significant harm and contributing positively to the environment — bonds that passed our “Sustainable Investment (SI) Sovereign Labeled Bonds Screen.”² We compared this basket with the non-labeled bonds from the same 14 sovereigns (left-hand exhibit below).³ While the trend is not aligned across all the countries, the weighted average duration for the sovereign green bonds in the sample was 9.5 years, compared to 7.7 years for the non-labeled sample.⁴ This duration difference was particularly pronounced in eurozone countries such as France, Germany, Italy, the Netherlands and Spain. This suggests that investors with a specific duration strategy may need to be careful selecting which SI sovereign bonds to buy.

This longer duration impacted returns over the past year. When analyzing the sample, the weighted average returns for most of the SI sovereign green bonds were lower than those for equivalent non-labeled bonds between June 2023 and June 2024, with this trend being particularly pronounced for eurozone countries, as shown in the exhibit on the right below.

The sample of EUR-denominated non-labeled bonds outperformed largely due to term structure. The EUR rate curve over the last 12 months has been inverted, with short-term yields falling more than long-term yields.⁵ As a result, the longer-duration group benefited less from the decline in short-term rates. The last 12 months were generally poor for sovereign bonds with higher duration; the average return for bonds in the shorter-duration groups was higher than the longer-duration groups.⁶ Green bonds issued by Denmark, the one exception to lower SI returns, benefited from this because its green bonds had marginally lower duration than its non-labeled counterparts. Like the EUR curve, DKK rates also fell more in the front end, resulting in stronger price appreciation for the shorter-duration Denmark SI bond sample.

The duration narrative may become more balanced if sovereigns issue more green bonds throughout their yield curves. It makes sense that green bonds are oriented toward a longer time horizon, however: They potentially signal to the market that a government is committed to sustainable development. Investors may want to bear in mind that there tend to be differences in duration profiles for investing in sustainable sovereign bonds.