In the age of climate change, green bonds have come into favor both for borrowers as well as investors. But what are green bonds, and how do they differ from traditional bonds?
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In many ways, green bonds are similar to “plain vanilla” bonds. They are securitized debt investments, issued by corporations and governments, that bear an interest payment to the bondholder and can be traded on secondary markets. The key difference, however, is that this debt must be designated to finance environmentally friendly projects — and as a result, can often come with benefits including preferential tax treatment.
That makes these instruments attractive, particularly to investors who want to put their money behind projects that align with their values.
A Brief History of Green Bonds
Green bonds first entered the marketplace back in July of 2007, when the European Investment Bank issued the first round of these securities.
Since then, total issuance of all “socially aware” bonds — including green bonds — stands at more than $2.2 trillion. The good news is that these markets are now deep and liquid, but the trade-off is that the popularity of these instruments has the potential to create confusion thanks to the wide variety of choices out there.
For instance, some investors erroneously refer to green bonds as “climate bonds.” While that is indeed a subset of green bonds, dedicated directly to offsetting carbon emissions or reducing an organization’s carbon footprint, green bonds are a much broader category that can include things like more responsible waste management or water efficiency. In other words, read the fine print carefully before you buy a green bond and simply presume it’s funding a solar or wind farm.
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Additionally, while green bonds are touted for benefits like exempting the shareholder from some tax burdens, this status can vary from instrument to instrument.
Adding even more to the confusion is that there are now “social bonds” that sometimes get erroneously lumped into the green bond space. These social bonds are intended to acknowledge the broader definition of sustainable finance, including job creation for distressed communities or efforts to support social justice, which may or may not have anything to do with the environment.
In short, green bonds have come a long way in the last 15 years. But their popularity and variety means that investors should do their research instead of just throwing their money behind the first option they come across.
How to Invest in Green Bonds
If you are really interested in this asset class, you should know that many green bonds are only accessible to institutional investors, not individuals. That makes it harder to get direct exposure to them, unlike the way you would buy U.S. government bonds right from the Treasury Department.
However, individual investors can invest in exchange-traded funds, or ETFs, and mutual funds that hold green bonds. Among the most popular options are the $300 million iShares USD Green Bond ETF (ticker: BGRN) and the $760 million Calvert Green Bond Fund (CGAFX). These funds are virtual grab bags of the green bond marketplace.
BGRN invests in dollar-denominated bonds, but don’t be fooled into thinking that the USD in its name means these are only domestic instruments. At present, the top position in this green bond ETF is occupied by European Investment Bank-issued green bonds. The lineup also includes bonds issued by foreign governments, including Israel, and the German-run KfW Development Bank.
The fund allocates about a third to government-issued debt and the other two-thirds to corporate green bonds. About 300 total holdings add up to a trailing yield of about 3.3%.
The Calvert Green Bond Fund yields less, at only about 2.3%. The fund offers a broader array of green bonds, though. Top positions include corporate bonds from companies, ranging from Apple Inc. (AAPL) to Bank of America Corp. (BAC), that are improving their operations with an eye toward sustainability. The fund also includes mortgage-backed securities from government issuers like Fannie Mae and Freddie Mac, which are funding single-family home loans dedicated to new construction that is energy efficient.
Whether your investment strategy includes either of these options or something completely different, the important thing to understand is that green bonds require research, just like any other asset. It’s up to you to understand the potential risks and rewards, and to figure out how these instruments fit into your personal portfolio.
One thing is undeniable, however. With an increasing focus on climate change and sustainable investing on Wall Street, green bonds are sure to be a viable option for a wide range of investors in the years to come.
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What Are Green Bonds? originally appeared on usnews.com
Update 08/29/23: This story was previously published at an earlier date and has been updated with new information.
