Opportunities and Risks of Green Bond Investing

The issuance of green bonds—tax-exempt bonds issued by federally qualified organizations and municipalities for the development of brownfield sites—has surged in recent years along with investor appetite for renewable energy.

The SEB, a European financial services group, predicted the 2022 green bond market could reach $400 billion, but then growth unexpectedly slowed, mostly to increasing interest rates and inflation. But a mid-year report from Climate Bonds Initiative indicates the green bond market may not be struggling as suggested, down only 1% from the previous quarter. Green bond issuance rose to $236 billion globally in the first half of 2022, down modestly from a record $240 billion in the first half of 2021. While the industry represents a lot of potential for growth, it also faces significant long-term risks.

Risks of Going Green

One of the largest detractors when investing in green bonds is a lack of liquidity. Being a small market, entering and exiting positions is not as easy as more popular investments. If yyou were looking for a liquid investment, then green bonds should be avoided, at least until the demand for new issuances is high and the market shows steady growth. Traditionally, they would be strongly considered as an investment to hold until maturity. However, in the current green bond investing climate, there are signs the market's liquidity is increasing, although investors should still proceed with caution.

Another risk is the lack of a clear definition for a green bond—investors might not know exactly where their money is going, meaning that it could potentially be used for the wrong reasons. One of the reasons is the lack of a "universally accepted legal" definition for a green bonds. Another reason is green bonds do not have state how the funds will be used to promote "green" projects.

Other risks for green bonds include: low yields, mispricing, a lack of sufficient complex research available to make an educated investment decision, and the existence of some green bond issuers with questionable reputations.

Another challenge is the demand for oil; as popular as alternative energy sources grow, there will need to be significant changes in costs and government policies to replace oil and petroleum products as the leading energy resource.

Budding Opportunities

Going green is a popular trend, and one that looks set to continue as long as interest grows and new investors are given environmentally-conscious investment options within their portfolios. Since 2020, governments around the world—including the U.S.—have enacted new regulations, which will, in turn, help many green projects. 

In 2022, U.S. enacted the Inflation Reduction Act, which is the "first multi-decade piece of legislation targeting dramatic long-term reductions in greenhouse gases via several targeted incentive programs supporting low-carbon technologies." The new act is expected to increase renewable production while decreasing other "high-carbon" energy sources.

Green bonds are gaining popularity in the U.S. For example, in May 2013, Tesla Motors, Inc. (TSLA) issued a $600 million convertible green bond. In March 2014, Toyota Motor Corp (TM) issued asset-backed security to finance hybrid vehicle loans.

Green bond growth is evident in the U.S., but popularity began with power companies in France. This is more of a global story than a domestic one. Here are some supranational issuers of green bonds:

• European Investment Bank
• African Development Bank
• European Bank for Reconstruction and Development
• World Bank

On top of that, the World Economic Forum suggests that $700 billion per year needs to be invested in clean energy, transportation, and forestry. The International Energy Agency recommends an investment of around $1 trillion per year toward a low carbon economy by 2035.

Other corporate green bond issuances include:

• Vasakronan (a Swedish real estate company)
• Unibail-Rodamco (commercial property in Europe)
• Unilever plc (UL)
• SCA: Svenska Cellulosa Aktiebolaget (Europe's largest private forest owner; it has ambitions to pursue profitable and responsible forestry activities)
• Skanska (a global project development and construction group)

You can also invest in green bonds directly via Calvert Green Bond A (CGAFX). As of September 2022, CGAFX hovers near its initial offering price and might be considered a buying opportunity as it bottoms out.

The Bottom Line

Green bonds are without a doubt on the rise, and that trend is likely to continue. However, if you’re the type of investor that seeks liquidity, then consider waiting until the market grows larger and more investment products are available.