How Green Bonds Are a Cornerstone of Responsible Investing
A green bond is a bond whose proceeds are used to fund environmentally friendly projects. These relatively new bonds are increasing in popularity with investors at an exponential rate. Green bond issuance for 2019 was $254 billion—the first recognized green bond was issued in 2008. The number of green bonds is expected to continue to climb, as awareness is built and more investors become concerned with climate change.
Although they're a fairly new segment of the bond market, investors are sure to hear in the years ahead about the environmentally conscious offerings that define green bonds.
Green Bonds Help Environmentally Friendly Projects
Green bonds are designed to help the environment by directing portions of the capital raised to projects related to clean water, renewable energy, energy efficiency, river and habitat restoration, 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 while carrying credit ratings similar to other funds. 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 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 younger investors—whom the issuers can profit from over an extended period.
Higher demand for green bonds equates to lower borrowing costs. Lower borrowing costs means reduced expenditures, which are either passed down to the investor in the form of a dividend or used to lower the operating costs for exchange-traded funds (ETFs) or bonds.
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. In 2019, it issued over $13 billion in funding for issues related to climate change. In the years since it's inception, the World Bank's green bond program has committed more than $30 billion to programs for renewable energy, transportation, forests, and disaster risk management in cities around the world.
Ginnie Mae and Fannie Mae have also issued mortgage-backed securities with the green label, as has the European Investment Bank. 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.
Massachusetts Clean Water Trust
The first U.S. entity to issue bonds that fund environmental issues was the Commonwealth of Massachusetts, which in June 2013 sold $100 million worth of 20-year notes it referred to as “green bonds.” The Commonwealth discloses the projects that have been funded with the bonds, providing socially conscious investors with the means to track how the money is being put to work.
Since 2015, the Commonwealth of Massachusetts Clean Water Trust has issued more than $643 million to fund developments in wastewater and drinking water infrastructure through the state.
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.
Green Bond Criteria
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.
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, performance may be somewhat lower than government debt due to the lower liquidity of green bonds. However, as more green bonds (or climate bonds, as some refer to them) are issued, liquidity will cease to be a major concern.
Can Individual Investors Buy Green Bond Funds?
As the market expands, offerings will become more diverse. There is 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:
- TIAA-CREF Core Impact Bond Fund (TSBIX)
- Domini Social Bond Fund (DFBSX)
- Parnassus Fixed-Income Fund (PRFIX)
- CSIF Bond Portfolio A (CSIBX)
- Praxis Intermediate Income Fund (MIIAX)
- Pax World High Yield Bond Fund (PXHAX)—a global fund
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 iShares 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, and 100 basis points in 2019.
HSBC Global Asset Management, in 2019, launched a green bond fund for emerging markets, further signifying the build-up of green investments and investor concern for the environment.
Green bonds may not yield the highest returns, but not all profit is quantifiable. Green bonds offer investors the option to diversify their portfolio with not only income-based decisions but environmentally based ones as well.