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How Investing in Green Bonds Drives the Renewable Transition

By Justin Kuepper
Oct 19, 2022
Most investors hold a diversified portfolio of stocks and bonds with allocations that change over time. Most of these bond allocations hold traditional government and corporate bonds that have little impact on the climate or other UN Sustainable Development Goals. But fortunately, "green bonds" offer a high-impact alternative.

Green bonds help finance environmental and sustainable projects rather than typical commercial projects. For instance, a company may issue a green bond to finance a solar array on their buildings. Or a government may issue a green bond to fund recycling efforts or clean transportation initiatives. And by investing, you're helping build these projects.

Evidence They're Helping

Green bonds help lower the cost of capital and finance projects that wouldn't otherwise qualify for investment. The easiest way to measure these benefits is to look at the "greenium" – or the higher price for green versus grey bond issuances. When investors pay a higher price, there's a higher level of demand, and issuers pay a lower yield.

In a new report, the Climate Bond Initiative found that green bonds can help issues achieve pricing benefits in the primary markets. In general, these benefits are most prevalent among USD-denominated instruments from issuers that cannot easily access the UoP market because they don't have the appropriate expenditures or assets.

"As the world is faced with the coming threat of climate collapse, earmarking capital for climate causes at scale marks a necessary evolution for the finance sector to embrace," said Climate Bond Initiative CEO Sean Kidney. "The market offers a great outlet for high emitters to cut climate impact, but commitments must be ambitious."

The report also found that green bonds have better liquidity in the secondary markets. As with the greenium, these dynamics confirm that there appears to be a shortage of green bonds as demand continues to rise. The benefit of more liquidity can help offset the "cost" of a lower yield for green bond investors.

How to Invest in Green Bonds

Most conventional and green bonds have a high face value and low liquidity compared to stocks. As a result, it's challenging and costly to build a bond portfolio by purchasing individual bonds. But the good news is that exchange-traded funds (ETFs) make it easy to buy into a diversified bond portfolio in a single "stock."

The two most popular green bond ETFs include:

These funds hold a portfolio of green bonds and may offer a drop-in replacement for a core bond allocation. For example, the VanEck Green Bond ETF holds a portfolio of 327 USD-denominated bonds designated as "green" by the Climate Bonds Initiative. And with a 0.2% expense ratio, it provides low-cost exposure within a portfolio.

The Bottom Line

The Climate Bond Initiative's new report shows how green bonds help support the transition to renewable energy through a greenium. At the same time, investors benefit from better liquidity and knowing that their portfolio is positively impacting the world. And, two green bond ETFs make it easier than ever to add exposure to your portfolio.

If you're looking for other ways to make a positive impact, we've built a database of more than 40 impact investment platforms and opportunities. Our Impact Guide can also help you come up with a plan to save for retirement while making a positive impact on the world.