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)
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. 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Green your Global Bond Portfolio
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