Investors searching for yield and a way to make a positive impact on the environment may want to consider green bonds. The assets are generally enjoying the same high yields currently seen in the bond market because they are essentially government or corporate bonds that target environmentally beneficial projects such as solar power and clean water. The iShares USD Green Bond ETF , for instance, is currently yielding 5.13%. “Structurally, we see significant investment potential in green bonds issued by companies and governments across both emerging and developing economies as a critical source of financing for the global energy transition,” Kay Haigh, Goldman Sachs Asset Management’s co-chief investment officer and co-head of fixed income and liquidity solutions, wrote in the firm’s third-quarter outlook in July. BGRN 1Y mountain iShares USD Green Bond ETF 1-year performance Green bonds are considered part of the growing asset class known as GSS+: green, social, sustainability, sustainability-linked and transition bonds, according to Morningstar. They have the same credit ratings as their specific corporate or government issuer’s regular bonds. “It’ll often have the same structure that a plain old regular corporate bond or sovereign bond would have, it’s just that they’ve promised you that the total amount of the principal that they’re getting through this bond is going to fund a specific project that they’re then telling you about — and that project is supposed to be green in nature,” explained Shannon Kirwin, associate director of manager research at Morningstar. What sets green bonds apart Green bonds tend to have longer durations than their general counterparts. That hurt their performance in 2022, when duration underperformed, she said. There also tends to be more corporate bond issuance, on average, in the space, she said. In addition, some sectors don’t issue green bonds. Others have a big role. For instance, utility companies are at the forefront of the energy transition and therefore green bond portfolios will have more exposure to them, said Bram Bos, global head of green, social and impact bonds at Goldman Sachs Asset Management. Exposure to banks is also higher, he said, since they finance renewable energy projects. “If you collect green bonds in a portfolio, the composition of your portfolio is a little bit different compared to a traditional fixed income portfolio,” he explained. “If you make a dedicated allocation to green bonds, you are collecting issuers who are more forward looking, more protected against ESG climate risks, and also more innovative.” While someone may invest in a green bond to make an environmental impact, there is also a financial one, said Stephen Liberatore, head of ESG/impact for global fixed income at Nuveen. The firm’s parent company, TIAA, invests in green bonds through its TIAA-CREF Green Bond Fund (TGROX) . For example, solar and wind power are cheaper to use because there are no fuel costs, so the more invested into the technology, the cheaper it becomes, he said. “There’s this compounding benefit that is attractive from not only the environmental perspective, but also from a financial perspective,” he said. “If you’re funding a utility who’s transitioning from fossil fuels to renewables, what is occurring is their cost of power generation is going down, which means their stability of free cash flow in the future is going up and that’s what you’re looking for in an investment.” ‘Potential yield enhancement’ While green bonds underperformed last year thanks in part to their longer duration, experts are now generally looking to add longer-dated bonds to their portfolios as the Federal Reserve looks to wind down its monetary tightening. The current inverted yield curve in the Treasury market, where short-dated bonds are earning more income than longer-dated ones, will not last much past the central bank’s hiking cycle, Liberatore said. “In a more normal environment, you think about green bonds as serving as a potential yield enhancement for someone’s portfolio,” he said. That said, the U.S. market for green bonds is a small one. Of the 113 funds Morningstar identified in its database as investing in GSS+ bonds, 92 are domiciled in Europe. Only a “handful” are available for U.S. investors. “The U.S. plays an important role in the green bond market, without any doubt. It’s just that it’s a little bit behind compared to developments in Europe,” Goldman’s Bos said. Where to invest Funds are the best place for retail investors to get exposure, experts said. For one, investing in individual bonds means you have to do a lot of work to make sure the structure and governance are well organized and you want to know that your investment is making an impact, Bos said. Also, the fixed income market is over the counter, where everyone transacts at a different price, Liberatore said. “An institutional investor is going to get a better level than you are going to get as a retail investor just because of size and in the ability to do larger scales of transaction,” he explained.
