Lower carbon emissions often indicate a country's commitment to sustainability, which can translate into long-term economic stability and reduced regulatory risks. These factors in turn can strengthen the attractiveness of that country’s bonds over time.

Carbon emissions declined in 2023 in many developed countries, according to data released last month by EDGAR (Emissions Database for Global Atmospheric Research). However, the data reveals uneven progress towards net zero. For example, the US is still emitting three times more CO2 per capita than European counterparts like France and the UK.

For investors who want to reduce the carbon footprint of their bond portfolio, this dispersion offers opportunities. They can shift their government bond investments towards countries with lower carbon emissions.

However, there are important risks to take into account when doing so. Some low-emission countries have a lot of long-dated bonds outstanding, like the UK. These countries’ bonds have a higher duration, which is the measure of how sensitive a bond’s price is to interest rate changes. Bonds with higher duration will see more significant price drops when interest rates rise, making them riskier in a changing interest rate environment.

For instance, while shifting investments from US to UK bonds might lower a portfolio's carbon footprint, it could inadvertently expose the portfolio to greater interest rate risk due to the UK's longer bond durations.

To this end, the graph below shows different countries, with each country represented by a bubble. The higher up the bubble is on the graph, the more carbon emissions that country produces per capita. The further to the right the bubble is, the more sensitive that country’s bonds are to interest rate changes (duration). The size of each bubble shows how much of that country’s bonds are included in the Bloomberg Global Treasury index.

Duration isn’t the only risk that needs to be managed. The low-emission countries within the Eurozone shown in the graph also tend to be countries with lower credit ratings, like Italy. And in the bottom-left of the graph, we find a number of emerging markets with low emissions that have higher country-specific risks as well, like Indonesia.

For investors, a sound approach to decarbonizing their bond portfolios combines the opportunity to support countries that are making strides towards a lower-carbon future, while still keeping an eye on market risks and potential returns. Taking duration and credit rating risk into account is an integral part of this process. More information on how Robeco approaches decarbonizing government bond portfolios is available in our white paper Efficiently reducing carbon emissions in government bond portfolios. In the paper we show that we decarbonize more while reducing the risk versus the index.