How to Invest in Green Bonds

What are green bonds?

Green bonds are debt instruments issued to finance projects that have a positive environmental impact. Unlike traditional bonds, the proceeds from green bonds are earmarked exclusively for green initiatives, such as renewable energy projects, energy-efficiency improvements, clean transportation, and general sustainability.

Just like traditional bonds, issuers can include governments, municipalities, corporations, and financial institutions. The key driver and distinction between traditional bonds and green bonds is the commitment to use the funds for positive environmental purposes.

History of green bonds

Depending on who you ask, the first green bond was issued either in 2007 by the European Investment Bank or in 2008 by the World Bank. Either way, green bonds have officially been around a while.

However, the concept can be traced back to 1760 and a sermon by John Wesley, called "The Use of Money." He explained how money can be used for good purposes, and the phrase "use of money" continues to be part of bond prospectuses today.

Ethical funds became more popular in the 1920s, with the first ethical mutual fund launching in the U.S. These excluded investments in alcohol and tobacco. The idea of the exclusion versus inclusion of companies or projects is what differentiated ethical funds from the day-to-day funds that were already being traded.

But as stated above, green bonds themselves didn't really find a footing until 2007 or 2008 but have since become popular vehicles for ethically minded traders. There are now even blue bonds, which are meant to be used to finance marine and ocean-based projects. The first blue bond was issued in 2018 by the Republic of Seychelles.

Types of green bonds

Green bonds come in various colors, shapes, and sizes, each tailored to specific issuers and project types. The table below shows some of the most common ones.

Green bond principles

Before issuing a true green bond, companies, governments, or institutions must abide by the Green Bond Principles (GBP). The International Capital Market Association (ICMA) established the GBP to provide voluntary guidelines for ensuring that transparency and integrity were part of the mix. The four core components are:​

1. Use of proceeds

This principle ensures that the money raised from a green bond goes to green projects, such as solar farms, energy-efficient buildings, or clean water systems. Investors want to know their money is helping the planet, not just funding general business expenses. For example, if a city issues a green bond, the proceeds may be allocated specifically to building electric bus lanes, not repaving roads.

Examples of green bonds

Toronto

Toronto has raised almost $1 billion through green bond issuances to fund various environmental projects. This initiative allowed the city to reduce its reliance on federal funding and expedite important infrastructure developments aimed at achieving environmental stability.

Asheville, North Carolina

Asheville's Water Resources Department issued a green bond to upgrade its drinking water infrastructure. The proceeds were used to replace failing water lines, enhance water tanks, and install emergency generators, which resulted in reduced water leaks.

Apple

Apple (AAPL -2.21%) issued a $1.5 billion green bond in 2016, marking the largest U.S. corporate green bond at that time. The proceeds were allocated to projects aimed at reducing the company's environmental impact, including renewable energy installations, energy-efficiency improvements in facilities, and sustainable materials sourcing.

How to invest in green bonds

Investors can access green bonds through various channels:

1. Direct purchase of green bonds

Much like buying regular bonds, investors can buy individual green bonds through most major brokerage accounts. In most cases, these are issued by governments, municipalities, or large corporations to fund eco-friendly projects.

For example, a company trying its hand at cheap water desalination might raise bonds for a specific project that utilizes a new, promising technology. This method can give you direct exposure to a specific project, but always do your homework before investing in anything that a company assures you is both green and a can't-miss investment.

2. Investing through green bond funds

Most people won't know a lot about the specifics of green projects, so funds are a great option to gain exposure to green bonds without picking winners and losers. Mutual funds and exchange-traded funds (ETFs) that specialize in green bonds are popular alternatives to picking specific green bonds. These funds pool money from many investors and distribute it across multiple green bonds for diversification.

3. Tracking green bond indexes

Green bond indexes, such as the Bloomberg Barclays MSCI Green Bond Index, track the overall performance of the green bond market. While you can't invest directly in an index, you can invest in funds that follow it and use it as a benchmark for your own investments.

4. Using sustainable investment platforms

Online investment platforms, such as Wealthify and Abundant Investments, now offer access to sustainable and environmental, social, and governance (ESG)-focused investments, including green bonds. These tools often curate options that meet environmental criteria, making it simple for retail investors to get involved. Some even allow you to filter by specific causes, like clean energy or saving whales.

Pros and cons of investing in green bonds

Investing in green bonds is often something people do because they're at least somewhat interested in supporting green initiatives like clean transportation or green energy projects. Here are the pros and cons to consider:

Pros

• Green bonds support sustainability projects, which can be great for the planet.
• Demand is increasing, which also creates the potential for gains on the secondary bond market prior to your bond's maturity.
• These bonds often have high credit quality due to backing from the government and blue chip companies.

Cons

• Some green bonds may be greenwashed and have only the appearance of actually supporting sustainability and environmentally friendly projects.
• Reporting on environmental impacts isn't always transparent, so it can be difficult to know which bonds are actually doing what they say.
• Green bonds can have different risk profiles than other bonds, due to regulatory pressures and ebbs and flows in the interest in green projects.

Related investing topics

What to look for when investing in green bonds

Investing in green bonds is much like investing in any bonds -- you want to make sure the payout is worth the risk of the project failing, and you want to be sure that you're giving your money to a legit organization. But there are some specific elements to green bonds to watch, as well.

• Where the money goes: Use of proceeds is one of the most important things to watch with green bonds (after the initial risk-reward calculations have been made). You want to be positive that the money will go to projects you support and that are truly green. If the projects aren't described clearly and in detail, it might be a good idea to pass.
• The issuer's green bond framework: There are a few green bond frameworks that issuers follow and some that just do what they want without care. Following the framework provided by ICMA, the Climate Bonds Initiative, or the EU Green Bond Standard will ensure that projects are following recognized guidelines. Also, find out who approves the projects and what kind of oversight is involved.
• Reporting quality: The depth of reporting varies from bond to bond, but you want a bond with solid reporting that includes things like allocation reporting, impact reporting, and methodology transparency. Reporting should also be regular and very easy to find -- if you have to hunt for it, they may be trying to hide something.

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