What Are ESG Bonds?
Environmental, social, and governance (ESG) bonds benefit investors as traditional bonds do, with the added appeal of funding positive change in the world. These debt instruments attract income investors who appreciate low volatility and the opportunity to put their money toward the greater good.
Let's explore the landscape of ESG bonds, including what they are, how they're used, and how you can add ESG debt securities to your investment portfolio.
An ESG bond is a debt security that funds an environmental, social, or governance goal. For example, a municipality can issue ESG bonds for community development projects, or a corporation might use them to fund solar energy projects, waste reduction, or other environmental targets.
As with any debt security, the issuer of an ESG bond is a borrower, while the investor or bondholder is the lender. The issuer pays the bondholder interest at specified intervals, and the rate is often fixed. When the bond matures, the issuer repays the principal, and bondholders get their money back.
Two additional points:
An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once.
ESG and traditional bonds generally provide stability and income within an investment portfolio. Bonds' repayment terms don't change, and their values don't fluctuate like stock prices. However, bond values can rise or fall in response to changes in prevailing interest rates.
According to Bloomberg, "impact" bond issuance totaled more than $939 billion in 2023. That's up 3% from the prior year and down slightly from 2021's $1.1 trillion issuance total. The Institute of International Finance reports that global ESG debt had eclipsed $6.5 trillion by mid-2024.
ESG bonds fund sustainability efforts. The bond can be issued to pay for specific projects or for general use. The purpose is established before bond issuance, so investors can choose how to deploy their funds. An ESG bond's purpose also dictates how the bond is categorized. Investment research firm MSCI (MSCI 1.14%) and others define four types of ESG bonds:
The advantages of investing in ESG bonds include:
The disadvantages of ESG bond investing are:
Investors can purchase ESG bonds directly from investment dealers, online brokerages, wealth management advisors, and other financial institutions. Alternatively, it may be simpler to invest in an ESG bond ETF.
ESG bond ETF portfolios can be broad or specific. Some focus on U.S. investment-grade, corporate bond issuers, for example, while others might offer worldwide exposure across corporate and government issuers.
The process for ESG bond investing is as follows:
ESG bonds provide lower-risk, reliable returns and often transparency relative to how the proceeds are used. However, the yields can be lower than non-ESG bonds. Whether that tradeoff is acceptable hinges on your values and investing goals.
The decision doesn't have to be all-or-nothing, of course. Your portfolio should include assets with a range of risk-adjusted returns, and your exposure to ESG bonds is only one piece of a greater whole. If you love the idea of funding sustainability-related projects in exchange for interest income, you can find an ESG bond position that supports your larger pursuit of financial returns.
ESG investing is a strategy that considers a company's ESG risks in making investment decisions. It may also be called sustainable investing.
Why is sustainable investing important? Advocates argue that corporations must do more than seek profits. They have the added responsibility of creating positive outcomes for people, communities, and the planet.
Some studies show that doing so contributes to profit-making. For example, companies with strong ESG records showed greater resilience than their counterparts in the market downturns of 2008 and 2018.
Investors are supporting ESG-forward companies and ESG funds, both for the returns and the positive impact. According to a 2021 Morgan Stanley (MS 1.32%) survey, 79% of all investors and 99% of millennial investors are interested in sustainable or ESG investing.
Poor governance, unsafe or unfair labor policies, data security issues, fossil-fuel dependence, water scarcity threats, and carbon-intensive business practices are all examples of ESG risks that can threaten a company's long-term profitability.
On the other hand, companies actively engaged in creating transparent governance policies, ethical labor practices, alternative energy production, or reduction of waste and emissions are managing those long-term risks to support future stability and growth.
Investors can gauge a company's ESG risks through the widely used ESG rating systems from MSCI USA or Sustainalytics. These ESG rating frameworks help investors evaluate and compare a company's ESG vulnerabilities. For climate-specific information, MSCI ESG research also includes a company's projected contribution to climate change.
Examples of companies with high ESG ratings include technology companies Microsoft (MSFT 0.3%), Apple (AAPL 1.03%), and Samsung Electronics (SSUN 0.0%). Software companies Adobe (ADBE 0.15%) and Intuit (INTU -6.83%) also score highly.
Across sectors, retailers Best Buy (BBY 2.8%) and Tractor Supply Company (TSCO 1.47%) and companies such as Vestas Wind Systems (VWDRY 2.66%), Enphase Energy (ENPH 6.5%), and Consolidated Edison (ED -0.07%) are ESG leaders because of their focus on renewables.
As a subset of ESG, investors can also choose to invest in conscious capitalism companies, such as Costco (COST 0.19%) and Starbucks (SBUX 1.72%), which prioritize an ethical approach to making money.
Green bonds are a subset of ESG bonds. ESG bonds are any bond with set environmental, social, and governance objectives. This can include everything from affordable housing to improved infrastructure, reduction of racial or gender inequity, or renewable energy.
Green bonds specifically focus on issues related to the climate and environment. Investors choose green bonds to support climate-forward policies and changes. Common green bond themes include renewable energy, alternative energy solutions, reduction of greenhouse gas emissions, or reduction of reliance on carbon energy sources.
ESG bonds are issued by corporations, municipalities, and governments. Globally, JPMorgan Chase (NYSE:JPM) and BNP Paribas (OTC:BNPQF) are the largest underwriters of ESG bonds. Major green bond issuers include Bank of America (NYSE: BAC), Apple, Walmart (NYSE:WMT), Citigroup (NYSE:C), Novartis (NYSE:NVS), the European Union, HM Treasury, and Deutsche Bank AG.
Investors can buy ESG bonds wherever they purchase other fixed-income securities. This includes wealth management companies or financial institutions, such as investment banks, online trading companies, or brokerages.
Catherine Brock has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adobe, Apple, Best Buy, Costco Wholesale, Enphase Energy, Intuit, MSCI, Microsoft, Moody's, and Starbucks. The Motley Fool recommends Tractor Supply and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.