Posted inFixed Income

Surging green bond market suffers diversification problem

Ratings agency Fitch said diversification has improved among green bonds with issuance up to $161bn in 2017 compared with $116bn in 2016.

But, last year it highlighted lack of diversification in issuers as a key challenge for the green bond sector. Sovereign, supranational and agency sectors remain high in green bond funds and indices, it said.

Asset managers our sister publication Portfolio Adviser spoke to also sought more products across the maturity spectrum, geographies and credit ratings.

Insight Investment ESG analyst Joshua Kendall says utilities and financials dominate corporate green bond issuance, but the asset manager wanted to encourage banks to lead on issuance given the significant weightings they represent in fixed income benchmarks.

Insight said on Wednesday it has written to 28 banks across the UK, Europe and emerging markets calling on them to increase their green bond issuance.

“There is an increased regulatory focus so it is inevitable that banks start to issue green bonds. We would rather they started to do it sooner rather than later,” Kendell says.

This month, the European Commission launched its Sustainable Finance Action Plan, which included recommendations to improve taxonomy across the sector.

Climate Bond Initiative spokesperson Andrew Whiley says Insight’s letter is part of a wider call in the industry for banks to step up on green lending and investment. In particular, the focus in the last two years has turned to the top 100 banks alongside the top 100 carbon emitters.

“Institutional support from banks should come from two directions: green bond issuance and green loan programmes on one side and increased underwriting support on the other side,” Whiley says.

Barclays, HSBC and the Chinese bank ICBC have all issued green bonds, as have Australia’s big four lenders. In February, Spanish bank BBVA announced it would commit €100m to green energy projects by 2025.

Quantity over quality

Utilities and banks were agreed to be the most dominant sectors, while supranational banks and governments were also a strong source of issuance, which meant many green bonds were AAA or AA rated.

Banks are delivering on quantity when it comes to green bond issuance, but less so on quality, according to Jupiter Ecology Diversified fund co-manager Rhys Petheram.

Westpac and BNP Paribas are examples of banks bucking that trend, Petheram says, but many in the sector are failing to link green bond issues to a long-term corporate strategy to improve sustainability.

Banks were also prone to one-off issues and were tagging green bonds against historical projects, he says. “Banks that issue once are probably just doing a marketing campaign.”

AAA issuers

Portfolio weightings to green bonds can be at the whim of tactical allocation due to the market’s lack of diversification.

The fixed income portfolio in the Jupiter Ecology Diversified fund currently holds about 25% in green bonds due to the prevalence of AAA or AA-rated issuers in the space.

Petheram says: “It’s creeping up but it’s not to do with the green bond market and is more a tactical tilt to make the portfolio more conservative. One of the advantages of green bonds for us is the chance to invest in these AAA-rated development banks.”

Whiley says recent sovereign green bond issues from France and Belgium have been oversubscribed. “Demand for quality investment grade green product is certainly outstripping supply,” he says.

At the other end of the spectrum, Petheram says a lot of emerging market corporates are issuing green bonds.

“From a green perspective it’s good because there’s a lot to be done, but from a portfolio point of view we don’t want to be filling our portfolio with high yield, emerging market debt,” Petheram says.

“There’s a lot of very interesting companies, but there’s only so much I can take into a cautiously managed portfolio.”

Duration

Rathbone Ethical Bond Fund assistant manager Noelle Cazalis says she would like to see more corporates dipping their toes in the green bond market, bringing various levels of credit risk and longer-dated issuance to the table, to allow investors to benefit from higher yields.

“The sterling market for green bonds is very small, with less than 10 green bonds outstanding, and most bonds are issued for less than five years,” Cazalis says.

The Sterling Corporate Bond sector hasn’t materially participated in the market as a result.

Petheram agrees the green market is dominated by short and medium-dated issues, which could impact investors as they start to move into longer-dated bonds.

“Tactically, I’m happy to start increasing duration in the US only. I’m finding that a bit harder with green bonds. It’s easier with green corporates, such as rail and water companies, and waste management companies.”

He says Berkshire Hathaway has issued a long-dated green bond, but the market is in “bits and pieces here and there”.

Kendall says Danish energy company Orsted became the first long-dated green bond issuer in Europe when it issued a 100-year green bond in November.

Green bond funds

Insight currently does not offer green bond funds, but last year it launched the Sustainable Euro Corporate Bond fund, which includes allocations to the product. While the asset manager has managed segregated mandates in sustainable fixed income, the product is the first for third-party distribution.

The asset manager added 43 green bonds to client portfolios in 2017, more than any other year.

Kendell says the green bond market is not big enough for Insight to create a dedicated green bond fund.

“The supply is very limited and the sector issuance is dominated by utilities and financials, so you don’t get the diversification. We do see a place for them in a general sustainability fund,” he says.

However, Fitch says 2018 will be a seminal year for Europe-domiciled green bond funds as the first products reach their three-year track record, which could serve as fillips for inclusion on intermediary buy lists and, ultimately, increased retail investment. Nine funds representing around €1bn assets would reach the milestone by the end of the year, the ratings agency said.

Last March, Lyxor Asset Management launched the first investment-grade green bond ETF. The €52.7m Lyxor Green Bond (DR) UCITS ETF has a total expense ratio of 0.25% and tracks Solactive Green Bond EUR USD IG Index, which focuses on investment-grade green bonds issued by sovereigns, supranationals, development banks and corporates.

Camilla Ritchie, who has led on the 7IM Sustainable Balance Fund since launch over 10 years ago, says she has researched green bond funds, but does not currently have any exposure. She said the bond manager she is currently invested with has raised concerns about the liquidity of green bond issues.

Whitechurch Securities investment manager Amanda Tovey says they are not invested in dedicated green bond funds as there are not many available.

Instead they invest in sustainable funds, which may have green bond exposure, including the Rathbones Ethical Bond fund, as well as the Threadneedle Social Bond and Kames Ethical Bond funds.

Fitch estimates the total AUM in Europe-domiciled green bond funds sits at €2.5bn.

Jessica Tasman-Jones

Jessica Tasman-Jones is news editor at Portfolio Adviser and covers fund selection, asset allocation and portfolio construction for intermediaries, as well as industry news and regulation. Previously she...

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