Green bond market expanding for investors interested in more than strictly returns

Riding a wave of growing focus on climate issues and sustainability, green bonds are a small but rapidly emerging segment of the global investment landscape.

Combined with record inflows of cash to investment products that emphasize sustainability or environment, social and corporate governance (ESG) issues, green bonds have posted record numbers of new issuance this year.

Green bonds are issued by governments and corporations to raise money for clean energy and environmental projects, such as solar farms or pollution mitigation. It’s not only renewable energy companies that offer these bonds. Companies in many sectors, such as Coca-Cola, Google and Visa have recently issued green bonds to fund projects related to reducing their carbon footprint.

The green bond designation debuted in 2007 with bonds issued by the European Investment Bank and World Bank. In order to raise money to begin to make the transition to a low-carbon global economy, with reduced emissions and more renewable energy sources, global policymakers have suggested that the market for green bonds will need new bond issuance of more than $1 trillion per year. It appears that green bond issuance this year will surpass the $255 billion in green bonds that were issued in 2019. That was a 49 percent increase over 2018.

This emergence of funding for clean energy and low-carbon projects comes at the same time that Bloomberg New Energy Finance reports that, due to COVID-19 impact, emissions from fuel combustion peaked in 2019. Harmful emissions will likely rise again but are projected to stay below 2019 levels. That is partly due to projects funded by green bonds. These projects focus on generating more renewable power, better storage and transfer of that power through the grid and improving efficiency of electric vehicles and the infrastructure needed to support them.

Green bonds are eligible for investment managers to use with other bonds not specifically earmarked to fund clean energy projects. You might already own some green bonds in a more traditional bond mutual fund. However, because their availability is becoming more widespread, there are now mutual funds and exchange-traded funds (ETFs) that invest only in green bonds. Calvert, PIMCO and TIAA offer green bond mutual funds. Two ETFs, iShares Global Green Bond and Van Eck Vectors Green Bond, are also available to individual investors. Thus far, their investment return performance has been in line with other types of government or corporate bonds of comparable maturities and credit quality.

Most of the green bond funds hold much of their portfolio in non-U.S. bonds, particularly because Europe is well ahead of the U.S. on issues related to sustainability and climate.

Of course, there are many other investment funds that meet the criteria for sustainability or ESG and are not limited to investing only in green bonds.

Some due diligence beyond the green bonds label may still be required by investors. For instance, if a coal company offers a “green” bond to fund a project to transition to “clean” coal, that might not fit many investors’ definition of a positive move away from fossil fuels. Green bonds might also be referred to as climate bonds or sustainability bonds.

As with the broader consideration of investments that screen out undesirable companies or industries in order to emphasize environmental stewardship, social responsibility or corporate governance, green bonds require a values judgment in addition to a business judgment.

Investors wishing to express values-based preferences in their investments have had more options on the stock side of the portfolio historically, but the emergence of green bonds is one more piece that allows an ESG-focused investor to implement a more complete, globally-diverse investment strategy.

Continued development in this area means that much of the spectrum of capital markets (stock and bond offerings as well as other forms of financing) are integrating sustainability into their decision making. Companies that evolve beyond short-term thinking about what is best for shareholders to longer-term thinking about what is best for all company stakeholders (employees, customers, the environment, etc.) might be able to develop more sustainable businesses. The ESG lens can provide a viewpoint in addition to traditional financial metrics upon which to evaluate the attractiveness of an investment.

There is a clear inflection point of awareness and demand for investments that consider impact along with profitability. By the end of July, U.S. investors had moved more money into funds with sustainability of ESG mandates than in any prior full year. Inflows in 2020 are set to double 2019 and set a new record for the fifth consecutive year.