What Are Green Bonds? Know Your Investments
Green bonds are on the rise, with green bond investments projected to hit USD $100 billion this year — almost three times as much as the $36 billion in 2014, which was more than double the $11 billion issued in 2013.
Not only are the total investment amounts increasing every year, but major financial institutions are issuing their bonds alongside smaller municipalities. In addition to countries across North America and Europe, nations such as China, India, and Brazil, are issuing their own bonds. Cities such as Seattle and Los Angeles, and the state of Massachusetts, have also harnessed the power of green bonds to fund projects.
But what makes a green bond “green”? How does it compare to a standard bond? How do you choose a good green bond to invest in? Today we’ll answer these pressing questions.
What Makes a Green Bond “Green”?
The defining aspect of green bonds is that the proceeds go toward some sort of sustainability project. Many people equate green bonds with mitigating climate change. While this is true, it’s not the only way to use green bonds. For example, “green” bonds could entail projects for environmental cleanup, water treatment, and even eco-friendly real estate or park development. Green bonds have even been used to retrofit streetlights to use LED bulbs, which not only draw less power, but reduce maintenance costs and provide better visibility.
Some bonds specifically earn the label “climate bonds.” These are geared exclusively toward carbon-reduction and renewable energy projects.
How Do Green Bonds Compare to Regular Bonds?
Apart from the purpose of the bond, green bonds function in the same way as traditional bonds: Someone issues the bond, investors buy them. In exchange for the funding, the issuer agrees to pay it back within a set period at a set interest rate. As far as investments go, bonds are typically considered one of the lowest-risk investments.
That’s not to say there are no risks. There are several risks, in fact. One of the biggest is that interest rates will rise, which negatively affects the price of a bond. Conversely, inflation may also decrease a bond’s value.
There’s also the default risk, which is the possibility that the issuer will be unable to pay the bond back. The good news is that Standard & Poor’s, Moody’s and Fitch rate the bonds issued to indicate their creditworthiness.
How Do You Choose a Green Bond?
First: It is always a good idea to consult an investment advisor or financial representative, someone qualified to help you make decisions about which products to invest in.
Checking the bond’s rating (as given by Moody’s, Standard & Poor’s, or Fitch) is a good way to find low-risk bonds from creditworthy issuers. An AAA (or sometimes “Aaa”) rating is the highest rating offered, but BBB (or “Baa”) or better is generally considered investment-grade.
The World Bank, JP Morgan Chase, PricewaterhouseCoopers, Bank of America, and other leading financial institutions have issued their own green bonds. Another great source for green bonds is municipalities, which typically rely on bonds to finance infrastructure projects.
It bears mentioning that not all green bonds are actually labeled as such. Generally, green bonds have undergone an independent (and voluntary) verification process to ascertain that the funds will be used appropriately. The International Capital Market Association issues the Green Bond Principles (GRP), the recommended guidelines for ensuring transparency. Some issuers may not choose to undergo the vetting process — but doing so certainly draws more attention, especially from environmentally minded investors, and builds trust.
What Now?
Impact investing — investments geared toward alleviating some sort of social or environmental problem — is more popular than ever. Many investors are no longer seeking just a monetary return; they want to know that they are doing something that will have a positive impact on the world. Green bonds are key to this. Comparatively low risk, green bonds also have a benefit in that many voluntarily implement transparency measures that ensure that your investment is having the intended effect. The market is constantly growing, providing a great opportunity to start “greening” your investment profile.
