THE BENEFITS OF GREEN BONDS

Let’s start with a brief refresher on bonds. For many investors bonds make up a sizable chunk of their portfolios. In general they are used as a key component of a balanced portfolio because they have historically provided a less volatile asset class that can help provide some downside protection.

When an investor buys a bond, they are in fact loaning some of their money to the issuer of the bond. That issuer can be a private company, a local government, or the federal government. The investor receives interest payments from the issuer of the bond for a stated amount of time, and then receives their initial investment back at the end of that time period.

What makes green bonds unique, is that the proceeds from the bonds are used to fund environmentally friendly projects. They are used to fund things like clean water, renewable energy sources, and mitigation of climate change impacts.

The bonds first arrived on the scene in 2007 with the “climate awareness bond” and have been booming ever since. In their first year the total amount of bonds issued was about $800 million. In 2020 that number had ballooned to over $250 billion. While many of the bonds are still issued by the World Bank, many other players are also beginning to enter the game. Most estimates expect that number to continue growing as the demand for the bonds still outpaces the amount available for investors to purchase.

Green bonds are generally asset-linked and backed by the issuing entities balance sheet. Thus they typically carry the same credit rating as as their issuer’s other debt obligations.

One of the biggest challenges to green bonds, is defining what constitutes a “green” bond. External review processes have emerged to help address this issue. While the process has improved there is still a wide variation in the external review process between different regions, and industries. The introduction of the Green Bond Principles by the International Capital Market Association in 2014 helped to standardize the process but it is still not a perfect process.

2014 also saw the launch of the first green bond indexes by Bloomberg and S&P. While those indexes are useful in tracking the performance data of the bonds, it wasn’t until 2017 that VanEck brought an ETF of green bonds to market. Currently there are two choices for passive investors interested in green bonds. The aforementioned VanEck GRNB fund, and iShares BGRN fund.

While it is rapidly growing, the green bond space remains very new. Because of that many questions about the performance and risk of the bonds remain unanswered. Because of the uncertainty, if you’re interested in the idea of green bonds, we recommend talking to a financial advisor about your specific situation to see if green bonds might be appropriate.