How Green Bonds Are a Cornerstone of Responsible Investing

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A green bond is a bond whose proceeds are used to fund environment-friendly projects. They are increasing in popularity with investors at an exponential rate. Green bond issuance in 2017 was $155 billion. One year later, that number is expected to clear over $250 billion.

Although they're a relatively new segment of the bond market, investors are sure to hear in the years ahead about the environmentally conscious offerings that define green bonds.

How Green Bonds Help Environment-Friendly Projects

Examples of green bond projects are those related to clean water, renewable energy, energy efficiency, river and habitat restoration, acquisition of land, or mitigation of climate change impacts. Many bond funds invest a portion of their capital to such causes, but green bond funds are those specifically invested in environmental initiatives.

Green bonds typically carry the same credit rating as their issuers’ other debt obligations.​

The Benefits of Investing in Green Bonds

Green bonds provide investors with a way to earn tax-exempt income with the benefit of personal satisfaction, knowing that the proceeds of their investment are being used in a responsible, positive manner. The issuers of green bonds also benefit, since the green angle can help attract a new subset of investors, namely younger investors, whom the issuers can profit from over an extended period vs. a base of older investors.

Higher demand for green bonds equates to lower borrowing costs. Lower borrowing costs means reduced expenditures, which are then passed down to the investor in the form of a dividend or lower operating costs for the exchange-traded fund (ETF) or bond.

The World Bank and the Green Bond Program

The first entity to issue green bonds was the World Bank, which began the practice in 2008 and has since issued over $3.5 billion in debt designated for issues related to climate change. Ginnie Mae and Fannie Mae have also issued mortgage-backed securities with the “green” label, as has the European Investment Bank. In the ten years from 2008-2018, the World Bank's green bond program surpassed over $10 billion from the issuance of green bonds, issuing over 130 bonds in 18 difference currencies during the same ten-year period.

U.S. municipalities have been issuing bonds for the specific purpose of funding environmental projects for several years, although usually without an easily identifiable green designation. Still, $1.7 billion worth of bonds were issued within this category during the first half of 2013.

The Success of the U.S. Green Bond in Massachusetts

The first U.S. entity to use this specific term was the Commonwealth of Massachusetts, which in June 2013 sold $100 million of 20-year notes it referred to as “green bonds.” The Commonwealth discloses what projects have been funded with the bonds, providing socially conscious investors with the means to track how the money is being put to work. For example, In April 2017, the Commonwealth of Massachusetts sold over $1 billion in a mix of green bonds, using the proceeds to fund developments in water infrastructure through the state.

These examples are important considerations, since the specifics of what constitutes a “green” investment are somewhat open to interpretation, although with more bonds being issued regularly, the definition is tightening as the market expands.

These issuances proved popular among both individuals and institutions that are compelled, by charter, to dedicate a portion of their cash to green investments. The success in Massachusetts prompted other states and municipalities to follow suit.

Generally speaking, it's reasonable to expect that green bonds will deliver longer-term returns in line with government issues, given that their cash flows generally come from projects with government sponsorship, and the subsequent protection inherent to municipal projects. In the short term, however, performance may be somewhat lower than government debt due to the lower liquidity of green bonds, although as more are issued, liquidity will cease to be a major concern.

Can Individual Investors Buy Green Bond Funds?

The short answer is yes. As the market expands, offerings will become diverse. There are already a substantial number of individual bonds and ETFs, and this development is likely to run parallel with the growth in renewable investments.

Investors also can choose broader socially responsible funds. There aren’t many bond funds available in this arena, as stock funds make up the bulk of the environmental, social, and governance (ESG) universe.

Nevertheless, some of the current choices include the TIAA-CREF Social Choice Bond Fund (TSBIX), Domini Social Bond Fund (DFBSX), Parnassus Fixed-Income Fund (PRFIX), CSIF Bond Portfolio A (CSIBX), Praxis Intermediate Income Fund (MIIAX), and for those looking for a global (high-risk) option, Pax World High Yield Bond Fund (PXHAX).

Developments in Green Bond Funds

In 2015, two of Europe's largest insurers, Allianz SE and Axa SA, initiated green bond funds, as did State Street Corporation.

By 2016, industry news sources reported that Blackrock, the world's largest asset manager, was preparing to enter the green bond fund field. An ironic result of this explosion of interest is that in 2016 an emerging problem for fund managers was a growing shortage of green debt to buy. 

Blackrock succeeded, finding success with its iShared Green Bond Index Fund (IE), which since inception in March 2017 has seen some turbulent movement, but still outperformed BBG Barc Global Green Bond 100% EUR Hedged Index by around 50 basis points from mid-2017 to mid-2018.

In March 2018, VanEck’s Green Bond ETF (GRNB) won the Best New ETF award at the Annual awards dinner. Although it has posted lower returns than a five-year comparison with the S&P 500 (as of early August 2018, returns slightly over 66 percent, without dividends), GRNB still returned over 10 percent since its launch in March 2017.

Green bonds will not yield the highest returns, but not all profit is quantifiable. Green bonds offer investors the option to diversify their portfolio by not only income-based decisions but environment-based ones as well.