Why Invest in Green Bonds?

Green, social, sustainability-linked, and transition (GSS+) debt volumes surged in Q1 2023 to USD 204.8 billion as per the latest market report published by Climate Bonds Initiative. Green Bonds continued to be the most significant contributor to this segment, recording volumes of USD 122.9 billion and taking cumulative green bond issuance to an all-time high of USD 2.3 trillion by the end of Q1 2023.

With governments and corporations increasingly focused on transitioning to a low-carbon economy, green bonds have become the fastest-growing investment opportunity in the fixed-income space. Here, we take a closer look at the green bond market and highlight several ETFs for investors wishing to gain exposure.

What are Green Bonds?

The International Capital Market Association (ICMA) defines green bonds as any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects, and which are aligned with the four core components of the Green Bond Principles (GBP). The European Investment Bank (EIB) issued the first Green Bond in 2007, called the Climate Awareness Bond (CAB), followed by the World Bank in 2008. However, the market for green bonds saw a huge uptrend after the adoption of the UN Sustainable Development Goals (SDG) and the Paris Agreement on climate change in 2015.

The EU's Ambitious Plans to Build a Greener Europe

The European Commission (EU) is geared up to become the world's largest issuer of green bonds via the NextGenerationEU green bond program with a target of €250 billion by the end of 2026. As a part of this plan, the EU unveiled the first NextGenerationEU green bond in October 2021, garnering €12 billion; this was the world's largest issuance of a green bond. The bond was oversubscribed more than 11 times, highlighting investor appetite for this investment opportunity. Earlier this year, the European Parliament and the Council of the European Union agreed on the European Green Bond Standard (EUGBS) to bring more transparency into this segment.

Why Invest in Green Bond ETFs?

Green bonds have become an essential source of finance to meet the vast requirements needed in the energy transition. Investors have also shown great interest in investments that give them financial returns and help them invest responsibly.

From an investor perspective, the ETF wrapper offers a convenient and cost-effective way to access the investment potential of the growing green bond market and support decarbonization efforts. Benefits include:

Portfolio diversification: Green bond ETFs typically offer broad diversification benefits, providing access to various sectors, such as renewable energy, green buildings, and clean transportation, often spread across different geographic regions. A diversified portfolio like this can help mitigate overall volatility while enabling investors to access many opportunities.

Enhanced liquidity: As bond ETFs trade on an exchange – with investors able to buy and sell throughout the day – they typically offer a much higher degree of liquidity than single bond issues which can vary widely in terms of their ability to trade. This is an important point, particularly in times of market stress when some bonds may cease to trade at all.   Indeed, a key strength of Fixed Income ETFs over single bonds – which goes beyond Green Bonds - is their capacity to offer both cash and in-kind redemption giving easy access to illiquid underlying holdings.

Transparency benefits: The ETF structure has long been known for its transparency benefits with full details of underlying holdings typically published on a daily basis. And for green bond investors, full transparency on the bonds held within the ETF - specifically in relation to disclosure and reporting on the use of proceeds - is a critical consideration. Ongoing moves by policymakers to strengthen regulation in the green bond market should continue to help with this effort while also reducing the issue of greenwashing.

Green Bond ETFs for Investors

For investors looking to access the Green Bond market, Trackinsight’s ETF screener currently identifies 25 funds in the category, including the following: 

Lyxor Green Bond (DR) UCITS ETF (CLIM)  

Lyxor Green Bond (DR) UCITS ETF (CLIM) is currently the largest ETF in the category, with assets under management (AUM) of €402.97m. CLIM tracks the Solactive Green Bond EUR USD IG Index, a benchmark of EUR- and USD-denominated investment-grade green bonds issued by sovereigns, supranationals, development banks, and corporates. This ETF is well-diversified across geographies and sectors and has a TER of 0.25%.

Xtrackers EUR Corporate Green Bond UCITS ETF (XGBE)

Xtrackers EUR Corporate Green Bond UCITS ETF (XGBE) boasts an AUM of €264.15M. It aims to track the Bloomberg MSCI EUR Corporate and Agency Green Bond and, again, is well diversified across both sectors and geographies with a TER of 0.25%.

Franklin Euro Green Bond UCITS ETF  (XLON:FLRG) 

In contrast to the previously mentioned ETFs, Franklin Euro Green Bond UCITS ETF (XLON:FLRG)  is an actively managed ETF.  Provided by Franklin Templeton, the ETF invests at least 75% of its portfolio in green bonds with the rest in climate-aligned bonds. XLON:FLRG charges a TER of 0.18% and currently holds assets under management (AUM) of €233.58M

References:

• https://www.climatebonds.net/2023/05/sustainable-debt-jumped-17-start-2023-market-shows-recovery
• https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles_June-2022-280622.pdf
• https://www.eib.org/en/press/all/2022-308-15-years-of-eib-green-bonds-leading-sustainable-investment-from-niche-to-mainstream
• https://www.worldbank.org/en/news/immersive-story/2019/03/18/10-years-of-green-bonds-creating-the-blueprint-for-sustainability-across-capital-markets
• https://ec.europa.eu/commission/presscorner/detail/en/ip_21_5207
• https://ec.europa.eu/commission/presscorner/detail/en/mex_23_1301
  
  Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.