[This ETF Industry Perspective is sponsored by VanEck.]
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 emissions. 1
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.