Green Bonds: Growing Market of 'Socially Responsible' Investments

Socially responsible investments are trending among individual investors and businesses looking to promote environmental, social, and governance efforts (ESG). So-called “green bond” investing might help investors marry their long-term investment goals with their social values.

Green bonds were created to fund projects that have positive environmental and/or climate benefits, but, actually, they’ve been around for at least two centuries, long before the green label. In short, they’re municipal, corporate, and private bonds aimed at doing good. Examples include environmental projects like wetland reclamation, social and governance activities that fund affordable housing, fighting climate change, building renewable energy infrastructure, and more.

The money raised from green bond sales should be put directly toward "do-good" causes. Like their traditional counterparts, green bonds are considered loans to issuers with interest paid for a given period of time until the bond principal is repaid.

Long History of “Green” Projects

Government entities of all sizes have long used municipal bond funding to attempt to benefit the public good for economic development projects. These range from construction of the Erie Canal, which connected the Great Lakes to the Atlantic Ocean in the early 1800s, to funding recent infrastructure modernization projects throughout the U.S., according to a “Green Muni Bonds” July 2017 report authored by two lead portfolio managers for TIAA  Investments.

“While green projects are not exclusive to governments, public agencies are frequently behind significant green initiatives,” according to the report. Investor demand for responsible investment strategies is fueling a 133% drive to $8.72 trillion last year in what is called the “labeled” green bond market, the report says. (There is no legal definition of a green bond.)

Citing figures from the Forum for Sustainable and Responsible Investment, the report said that the market has soared compared to its $3.74 trillion in 2012. The report notes, however, that “the vast majority of all municipal securities that have a positive environmental impact do not carry the green bond designation.”

The Climate Bonds Initiative (CBI) said there has been $87.5 billion invested in bonds aligned with its definition of green since the beginning of the year. It expects 2017 to end with a total investment of $105 billion.

Voluntary Green Bond Guidelines

Although there’s no legal definition, green bonds do have widely accepted rules of the road known as the Green Bond Principles (GBP). These are voluntary guidelines and standards that lay out transparency and disclosure expectations for green bonds. The GBP were created in 2014 by a committee of the International Capital Market Association and updated in June 2016 to promote integrity in the development of the green bond market.

Some municipal bonds are favored for their tax-exempt status and their appeal as part of a diversified fixed-income portfolio. Some investors have shown enthusiasm for corporate-issued green bonds as well as the newest addition to the pack, exchange-traded green funds, which were launched for the first time this year.

There are plenty of things to consider before you venture into the world of green bonds, including:

• Be aware of what you’re purchasing. Sustainability might mean different things to different companies and municipalities; determine if their definition aligns with yours. Some bonds are called “green” but fund projects like coal-related energy. Read the fine print.
• The market for green bonds is much smaller than the overall bond market. So, lack of liquidity in the green bond market is something to consider.
• Most green bonds are taxable in the same way as ordinary government or corporate bonds. Some, however, are municipal bonds ("munis"), issued by states, counties and local levels of government. The interest on munis is typically exempt from federal income tax and, in some cases, state taxes as well. Some funds have a mix of both taxable and tax-advantaged bonds.
• Green bonds are fixed-income assets and are treated as such.
• Find out whether the issuer is stable. It might be easier to determine if a corporation is more financially sound than an emerging market country, which might be rattled by geopolitical issues, or, worse, warfare.
• Check the fees and expenses tied to the bonds. They can be hefty and eat away at any returns.
• As with any investment decision, do your homework, research the details, and never forget that past performance is no guarantee of future results.

Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk and special tax liabilities. May be worth less than the original cost upon redemption.