One of the fastest growing segments of the fixed income market is also one of its greenest.
Green bonds, which finance everything from infrastructure improvements to mass transit to renewable energy projects and energy-efficiency initiatives, saw about $81 billion in corporate, municipal and sovereign issuances last year, according to the Climate Bonds Initiative (CBI), and are estimated to be $130 billion in 2017.
Indeed, Bloomberg notes that while green bonds are still a small fraction of the overall debt market, their issuance has grown dramatically; the Climate Bonds Initiative reported a record $56 billion of green bonds was issued during the first six months of 2017.
Citing HSBC analysts, the news service said that “evidence is mounting that bonds that finance environmental projects perform better than conventional ones,” noting that green bonds trade closer to benchmarks than regular debt issued by the same entity. “There is value in green bonds for bond investors…the conclusions are likely to cheer supporters of responsible investing, who say that investors can do good and generate healthy returns at the same time.”
Before entering the space, however, investors and their advisors should understand the nuances of this emerging fixed income sector, as new issuers are coming to market with a variety of innovative products. And while it’s quickly getting crowded, here are five important things to know:
1. A ‘Green’ Definition
The momentum of continued green bond issuance and market demand has led to growing consensus on what constitutes a green bond. Put simply, green bonds are just as described—those created to fund projects that have positive environmental and/or climate benefits, CBI notes. Green bonds are generally defined by the use of proceeds being green or sustainable projects, not by the sources of repayment, which are often identical to non-green bonds from the same issuers. It should also be noted that individual investors may also have strong convictions against investing in some bonds issued that are considered to be green, e.g., bonds issued to finance nuclear and/or hydroelectric power projects.
2. Buyer Beware
While investor enthusiasm for green bonds has grown, the fundamentals of bond investing still apply. And just because a green bond is issued for good purpose—or the company issuing it is a sustainable business—it doesn’t always mean that it will be good for a particular investor’s portfolio.
Investors should remove any “rose-colored glasses” that too often accompanies green investing and look at the fundamentals—credit quality, financial stability, yield and other factors—when selecting a green bond, just as they would (or should) with any other sector.