The Rise of Green Muni Bonds
Investors in green bonds should consider the potential trade-offs between investing for environmental impact and investing for return and capital preservation.
In August, the United Nations Intergovernmental Panel on Climate Change reported its increasing certainty that higher temperatures and more volatile weather lie ahead. The predictions are similar to those in its earlier reports, but the heightened certainty implies an increasing need for civilization to adapt to the changes.
For investors who want their money to fund projects that help do that, bonds offer more opportunities than ever. According to Moody's Investors Service, $375 billion worth of bonds that fund climate- and environmental-focused projects are likely to be issued in 2021, a 39% increase over 2020.
Bond boom
But while there are more bonds calling themselves "green" than ever before, the amount of environmental benefit that the activities they fund deliver may vary significantly and standards that measure what "green" means are still evolving. For example, many so-called sustainability bonds issued by corporations may be used for a wide variety of purposes.
A muni solution
While labels such as "green" and "sustainable" are relatively new in the bond ecosystem, municipal bonds have long funded projects such as clean water, power, and sewage systems that have clear environmental benefits. Since 2013 when Massachusetts issued the first munis labeled as "green," though, municipalities have been marketing bonds that fund these projects to the growing audience for environmentally conscious investments.
These green muni bonds resemble most other muni bonds in most ways. For example, green general obligation bonds are backed by the same full faith and credit as other general obligation bonds, pay the same tax-exempt income, and carry the same low risk of default.
For all their similarities to conventional muni bonds, green munis also differ from them—as well as from many other green-labled bonds—in the aspect that interests most investors in the first place: their "greenness."
The projects that green munis fund are required by law to serve an environmentally friendly purpose. Unlike some other green labeled bonds they also provide investors with abundant detail about both projects and purpose. For example, a 2020 green bond issue by the Portland Water District in Maine includes a 187-page report about the bonds, the issuer and its management and finances, and the improvements to drinking and wastewater systems that the bond proceeds will fund.
Knowing what you own
For many investors, the environmental benefits of green bonds have their own intrinsic value. But that shouldn't lead investors to overlook their investment characteristics. Investors should always research any bond's credit quality, yield, and duration and how allocating a portion of their portfolio to bonds aligns with their investment objectives.
What about performance?
Fidelity Capital Markets strategists Ilya Perlovsky, CFA and Tom DeMarco, CFA have sought to quantify the benefits of going green by comparing the performance of green bonds to global bond indexes, and the performance of tax‐exempt municipal green bonds to taxable US green bonds.
Their research found that the performance of green bonds generally appears to track the performance of similar conventional bonds, and that there was not a statistically significant difference between green bonds and their conventional counterparts, neither from the investor's standpoint nor from the issuer's.
Perlovsky and DeMarco found that since 2014, the municipal green bond index cumulative total return outpaced the parent index by 311 basis points, although most of the outperformance came prior to 2019, and in 2020, the municipal green bond index underperformed by 347 basis points.
How to use green muni bonds
While tax-free muni bonds are not well-suited for retirement savings in tax-deferred accounts, they may make sense as sources of income and portfolio diversifiers in taxable accounts. These could include ladders of municipal bonds in which the bonds are held until maturity.
While tax-free municipal securities can certainly be advantageous under certain circumstances, investors should consult their tax advisor for personalized guidance on the specifics of tax liabilities related to municipal securities.
If you have enough money and believe you have the time, skill, and will to build and manage your own portfolio, buying individual bonds may be appealing. Doing it yourself lets you choose specific bonds and hold them until they mature, if you choose. That can help you avoid much of the risk that changes in interest rates and prices might pose to investors in mutual funds. However, you still would face the risks that an issuer might default or call the bonds prior to maturity. So, this approach requires you to closely monitor the finances of each issuer whose bonds you're considering. You also need enough money to buy a variety of bonds to diversify away at least some risk. If you are buying individual bonds, Fidelity suggests you spread investment dollars across multiple bond issuers.
Investors can choose newly issued bonds or purchase previously issued bonds on the secondary market. You can use online tools to help screen for available bonds, build a bond ladder, set up alerts, and analyze your holdings with Fidelity's Fixed Income Analysis Tool. You can also read Official Statements which offer a wealth of information about the environmental impact and missions of these bonds and information about their issuers. Find out more about fixed income, bonds and CDs.