Income with Impact: The Investment Case for Green Bonds

Apr 19, 2017 @ 12:01 am

By William Sokol, Product Manager, VanEck Vectors ETFs

Green bonds allow fixed income investors to both fulfill their investment objectives and make a positive impact on the environment. With pricing levels between green and conventional bonds generally very close and highly correlated, the investment case for holding green bonds begins with the impetus for holding any fixed income investment: primarily, income and relative safety versus other portfolio holdings.

Given the market's significant growth in the past five years, green bonds are attracting interest not only from environmental, social, and governance (ESG) focused investors but from traditional fixed income investors who previously did not have an efficient way to "green" their portfolios.

What are green bonds?

Green bonds, in short, are simply conventional bonds with an environmentally friendly use of proceeds. Today, the overall market resembles a core global fixed income benchmark, with similar yield, duration and credit quality. Investors can, therefore, allocate a portion of their global bond allocation to green bonds without significantly altering the risk and return profile of their portfolio. In other words, bond investors can structure a more environmentally aware portfolio without having to compromise on their investment goals.

Apple issued a $1.5 billion green bond in February 2016, the largest issued by a U.S. corporation to date

Proceeds from Apple's green bond have so far been used to finance 16 projects across a variety of categories including renewable energy, green buildings, energy efficiency, and recycling/material recovery. Apple estimates that these projects will divert 6,670 metric tons of waste from landfills, generate 331mm kWh of renewable energy per year, and reduce greenhouse gas emissions by 191,500 metric tons per year. The bond was issued to build momentum ahead of the 2015 Paris Agreement where several governments pledged to reduce emissions1.

Where do green bonds fit within a portfolio?

The green bond market, as measured by the S&P Green Bond Select Index, which represents the investable global green bond market and includes all issuer types (excluding tax-exempt U.S. municipal bonds) across countries and currencies, generally resembles a high quality, core global bond allocation. With over 50% of its holdings rated AA and above, and nearly 40% U.S. dollar-denominated, as well as a yield and duration profile similar to the Bloomberg Barclays Global Aggregate Bond Index, the green bond market has risk and return characteristics comparable with the broad global bond market. As a result, replacing a portion of a core global bond allocation with green bonds may have minimal impact to an investor's portfolio. Because of the differences in sector exposures, adding green bonds may increase the diversification of a global bond allocation. For example, supranational issuers represent approximately 20% of the green bond universe versus only 2% of the Bloomberg Barclays Global Aggregate Bond Index.

Given the overall high quality of the green bond universe, the primary risks to an investor are interest rate and foreign currency risk. Because of their global profile, green bonds have exhibited low historical correlation to the broad U.S. fixed income market, suggesting potential diversification benefits within a U.S.-focused portfolio.

A potential hedge against climate risk

Lastly, for those who recognize the potentially significant effects that climate change may have on companies and governments in the future, the idea that adding exposure to green bonds may have minimal immediate impact to a portfolio's risk and return profile may represent a “free option” to hedge climate-related risks. Green bond issuers are addressing these risk factors, and in the case of project or revenue bonds, bond payments are directly tied to a green project. In a world where investors start to place a significant price on environmental risks, green bonds may provide protection versus a bond portfolio that does not take these factors into account.

Green Bonds are an Increasing Share of the Overall Global Bond Market

As debt-burdened governments grapple with the massive challenges of addressing climate change, private capital must play an integral role in financing the infrastructure needed to transition to a low carbon economy. Government actions to promote green finance and the continued development of green bond market standards will likely drive the growth that is needed. As a result, we expect green bonds to make up an increasingly large share of the overall global debt market, and consequently, within investors' core fixed income portfolios.

You can access the green bond market through VanEck Vectors™ Green Bond ETF (GRNB)

>>Click here to see GRNB holdings

Green your Global Bond Portfolio

Source: S&P Dow Jones Indices, Bloomberg Barclays and Morningstar, as of 2/28/2017. Green Bonds are represented by the S&P Green Bond Select Index. Global Aggregate Bonds are represented by the Bloomberg Barclays Global Aggregate Bond Index. Correlation based on monthly returns between the S&P Green Bond Index and the Bloomberg Barclays U.S. Aggregate Bond Index, July 2014 to February 2017. Yield as measured by yield to worst. Index returns are not representative of fund returns. For fund returns current to the most recent month-end visit vaneck.com

1Source: Apple, Annual Green Bond Impact Report, Fiscal Year 2016.

Important Definitions and Disclosures

Bloomberg Barclays Global Aggregate Bond Index tracks investment-grade debt from twenty-four local currency markets, and is comprised of treasury, government-related, corporate, and securitized fixed-rate bonds from developed and emerging markets issuers. S&P Green Bond Select Index tracks bonds issued globally to finance environmentally friendly projects. To be eligible, the bond issuer must clearly indicate the intended use of proceeds and the bond must be flagged as “green” by the Climate Bonds Initiative, in addition to meeting minimum size requirements based currency. The index includes treasuries, government-related, corporate and securitized issues. Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a fund. An index's performance is not illustrative of a Fund's performance. Indices are not securities in which investments can be made. Correlation is a statistic that measures the degree to which two securities move in relation to each other. Yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting. Duration is a measure of the sensitivity of the price of a fixed-income investment to a change in interest rates. Bonds with ratings BBB and above are considered investment-grade. Diversification does not assure a profit nor protect against a loss. This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction. The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck. An investment in VanEck Vectors Green Bonds ETF (GRNB) may be subject to risks which include, among others, credit rating downgrades, issuers that may be unable and/or unwilling to make timely interest payments and/or repay the principal on its debt, high yield securities risk, call risk, and interest rate risk, all of which may adversely affect the Fund. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. Changes in currency exchange rates may negatively impact the Fund's return. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors. The S&P Green Bond Select Index (the "Index") is a product of S&P Dow Jones Indices LLC or its affiliates ("SPDJI"). Standard & Poor's® and S&P® are registered trademarks of Standard & Poor's Financial Services LLC ("S&P") and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"). VanEck Vectors Green Bond ETF (the "Fund") is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, any of their respective affiliates (collectively, "S&P Dow Jones Indices"). Neither S&P Dow Jones Indices make any representation or warranty, express or implied, to the owners of the Fund or any member of the public regarding the advisability of investing in securities generally or in the Fund particularly or the ability of the Index to track general market performance. S&P Dow Jones Indices only relationship to Van Eck Associates Corporation ("VanEck") with respect to the Index is the licensing of the Index and certain trademarks, service marks and/or trade names of S&P Dow Jones Indices and/or its licensors. The Index is determined, composed and calculated by S&P Dow Jones Indices without regard to VanEck or the Fund. S&P Dow Jones Indices has no obligation to take the needs of VanEck or the owners of the Fund into consideration in determining, composing or calculating the Index. S&P Dow Jones Indices is not responsible for and has not participated in the determination of the prices, and amount of the Fund or the timing of the issuance or sale of the Fund or in the determination or calculation of the equation by which the Fund is to be converted into cash, surrendered or redeemed, as the case may be. S&P Dow Jones Indices have no obligation or liability in connection with the administration, marketing or trading of the Fund. There is no assurance that investment products based on the Index will accurately track index performance or provide positive investment returns. S&P Dow Jones Indices LLC is not an investment advisor. Inclusion of a security within an index is not a recommendation by S&P Dow Jones Indices to buy, sell, or hold such security, nor is it considered to be investment advice. S&P DOW JONES INDICES DOES NOT GUARANTEE THE ADEQUACY, ACCURACY, TIMELINESS AND/OR THE COMPLETENESS OF THE INDEX OR ANY DATA RELATED THERETO OR ANY COMMUNICATION, INCLUDING BUT NOT LIMITED TO, ORAL OR WRITTEN COMMUNICATION (INCLUDING ELECTRONIC COMMUNICATIONS) WITH RESPECT THERETO. S&P DOW JONES INDICES SHALL NOT BE SUBJECT TO ANY DAMAGES OR LIABILITY FOR ANY ERRORS, OMISSIONS, OR DELAYS THEREIN. S&P DOW JONES INDICES MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES, OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE OR AS TO RESULTS TO BE OBTAINED BY VANECK, OWNERS OF THE FUND, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE INDEX OR WITH RESPECT TO ANY DATA RELATED THERETO. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT WHATSOEVER SHALL S&P DOW JONES INDICES BE LIABLE FOR ANY INDIRECT, SPECIAL, INCIDENTAL, PUNITIVE, OR CONSEQUENTIAL DAMAGES INCLUDING BUT NOT LIMITED TO, LOSS OF PROFITS, TRADING LOSSES, LOST TIME OR GOODWILL, EVEN IF THEY HAVE BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, WHETHER IN CONTRACT, TORT, STRICT LIABILITY, OR OTHERWISE. THERE ARE NO THIRD PARTY BENEFICIARIES OF ANY AGREEMENTS OR ARRANGEMENTS BETWEEN S&P DOW JONES INDICES AND VANECK, OTHER THAN THE LICENSORS OF S&P DOW JONES INDICES. Fund shares are not individually redeemable and will be issued and redeemed at their Net Asset Value (NAV) only through certain authorized broker-dealers in large, specified blocks of shares called "creation units" and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading Fund shares in the secondary market. Past performance is no guarantee of future results. Returns for actual Fund investments may differ from what is shown because of differences in timing, the amount invested, and fees and expenses. Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will generally decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. 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