Takeaways
- Green bonds are debt securities issued to fund sustainable projects.
- Green bonds can be part of a well-designed, ESG-focused investment portfolio.
- Green bonds are structured like corporate, municipal, and other securities.
- Green bonds are tax-advantaged because they offer tax credits and exemptions.
- Green bonds fund projects like energy-efficient technologies, sustainable water management, and environmentally conscious energy development.
How a Green Bond Works
Green bonds are debt securities issued to raise funds for projects that positively impact the environment or climate health. They are structured like traditional bonds issued by governments, financial institutions, and corporations. Investors in green bonds receive periodic interest, or coupon, payments and a return of principal at the bonds’ term.
The most significant difference between conventional and green bonds is that the money raised by green bonds must be exclusively used on projects promoting sustainability. Sustainable investments include research and development for renewable energy, energy-efficient infrastructure, cleaner public transportation technologies, and similar climate-centric initiatives.
Independent third parties, such as the Climate Bonds Standards Board, verify green bonds.[1] This verification tells investors that the funds are genuinely being used for projects that benefit the environment.
Green bonds have exploded in popularity among investors over the last decade. In 2023, over $575 billion of green bonds were sold.[2] This growth has come as mutual fund, endowment, and pension fund investors seek to align their socially responsible values with their investment portfolios.
With more private companies, publicly traded companies, and governments trying to limit their ecological footprint, green bonds have become a popular way to finance these beneficial efforts while creating a financial incentive for investors.
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What Green Bonds Fund
Green bonds almost exclusively fund projects protecting the environment, reducing carbon emissions, and promoting a more sustainable development process. Some of the most funded projects include renewable power research in hydropower, solar, and wind.
Green bonds finance energy-efficient buildings and infrastructure upgrades, which can lower carbon emissions and overall energy consumption. These projects are at the forefront of migrating from fossil fuels towards cleaner and more sustainable energy sources.
See Also: What Is ESG Investing?
In addition to leading energy projects, green bonds raise funding for sustainable transportation systems, such as more accessible electronic infrastructure and public transit initiatives.
Other green bond projects fund forest conservation, sustainable agriculture, and projects focused on climate adaptation. They provide critical funding to protect biodiversity, restore degraded ecosystems, and build more eco-friendly agricultural frameworks.
Green bonds comfort investors by ensuring that their funds are slated toward energy efficiency and environmentally focused projects. Some bonds even clearly state their use of proceeds so that investors know exactly what they are funding.
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How to Buy Green Bonds
You can invest in green bonds the same way traditional bonds are purchased. Retail investors can find green bonds on their online stock brokerage platforms. Most platforms offer extensive research reports on green bonds. From there, you can curate your green bond investment to focus on investments in corporations, municipalities, or governments.
You can buy a basket of green bonds through a green bond fund if you don’t want to purchase individual green bonds. Mutual and exchange-traded funds also pool investment funds from many individual investors to provide exposure to sustainability projects focused on specific geographic regions, energy sectors, or entity types (e.g., public companies or government projects).
Institutional investors, such as pension fund managers and other larger asset management firms, often directly invest in green bond issuances in the primary market. Retail investors, on the other hand, will typically need to buy green bonds on the secondary market, where they are traded after their initial issuance.
Research your green bond investments thoroughly to ensure they align with your environmental values, investment time horizon, and risk appetite. Once you make your investment, you can monitor its performance and return.
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Pros of Green Bonds
Investing in green bonds can inject many benefits into your investment portfolio, and it’s vital to know the advantages this fast-growing investment class brings. Here are some advantages to consider:
- Environmentally Focused Investing: Green bonds' ethos is that bond issuance focuses on financing green projects. These bonds directly fuel positive environmental change, which can be just as important as an overall investment return for some institutional and retail investors.
- Regular Interest Income: Green bonds are structured similarly to other types of bonds. They offer interest payments, called coupon payments, to investors based on a set interest rate. Fixed-income investors gravitate to these types of investments to build predictable passive income streams that also pay them back their principal investment. (Investors focused on how to retire early or planning for retirement enjoy these investments).
- Medium-Risk Investments: Every bond investment has risk. However, green bonds are relatively low risk compared to junk bonds. Rating agencies like Standard & Poor’s and Moody’s rate each bond issuance, with the triple-A rating being the highest offered.
- Asset Class Diversification: Depending on your age, your investment portfolio should contain the appropriate mix of stocks, bonds, and other asset classes. If your portfolio is stock-heavy, bonds can inject much-needed diversification and buoy your portfolio. Bonds tend to be less risky than stocks and act as a conservative counterweight.
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Cons of Green Bonds
Even with a substantial list of benefits, green bonds definitely have some potential drawbacks you should be aware of before investing. Here are some you should certainly consider:
- Greenwashing: One of the biggest concerns for many ESG investors is "greenwashing," which occurs when issuers exaggerate or simply lie about the environmental benefits of their project and company. Green bonds have certifications and third-party audits to help validate their environmental focus and combat greenwashing. However, not all companies adhere to the same standards.
- Credit Risk: Like all bonds, green bonds don’t outrun credit risk, also known as default risk. Credit risk is the risk that the company issuing bonds, despite its best intentions, will default on its obligation to pay interest payments on time or your principal.
- Interest Rate Risk: Bond coupon payments are based on the interest rate for the bond. Depending on how the broader economy is doing, you could invest in a seemingly high-interest-rate bond. However, if interest rates begin to climb (for example, the Federal Reserve raises the federal funds rate to combat inflation), the price of your bond will decrease, making the investment less attractive.
Smart Summary
Green bonds are debt securities issued by companies, governments, and financial institutions to fund environmentally sustainable projects like clean energy technologies, transportation, or agriculture. Investors can purchase green bonds through online stock brokerage accounts and align their personal beliefs and investing strategies. If you don't want to purchase individual bonds, you can buy green mutual funds or ETFs.
(1) Climate Bonds Initiative. Climate Bonds Standard Board. Last Accessed January 13, 2025.
(2) Bloomberg. Green bonds reached new heights in 2023. Last Accessed January 13, 2025.
