Issuance of green bonds, which finance projects such as renewable energy technologies, has been soaring © Bloomberg
Green bond funds are under increasing pressure to find environmentally friendly fixed income products that meet their stringent investing criteria, despite a boom in green bond issuance.
The popularity of so-called green bonds, which finance projects such as cleaner waste treatment systems and renewable energy technologies, has soared over the past two years with issuance hitting $113bn last year, according to Fitch Ratings.
Recent large tranches of green bond debt issuance have come from Apple, which recently raised $1bn in debt to fund environmentally focused initiatives. Sovereigns have also become issuers. Poland became the first country to issue a green sovereign bond at the end of 2016 followed by France in January.
Dedicated green bond funds have also grown rapidly, but because of their tight investment criteria they are only eligible to invest in a small fraction of the green bonds issued, the rating agency said.
Of 17 funds in Europe, a region which accounts for the majority of these products globally, assets under management were only €1.4bn at the end of June. Of that, only about €1bn is invested in green bonds. Green bond funds sometimes exclude debt from certain sectors or companies regardless of whether the debt issued is defined as environmentally friendly. One recent example is that of Repsol whose €500m green bond issue in May was rejected by some funds given their environmental concerns over the Spanish oil group as a whole.
Their investment pool is further narrowed by concerns over whether it can be proved that profits generated by green bonds, once invested by the issuing company, are to be channelled into environmentally friendly activities.
Diversifying portfolios is also a challenge, Fitch said, as some sectors such as supranationals and utilities have issued far more green debt than sectors traditionally dominant in the corporate bond market such as financial and energy groups.
“They are facing a diversification challenge,” said Alastair Sewell, analyst at Fitch.
Fitch said 2018 would be a watershed year for the sector as several green bond funds will reach their third birthday; many institutional fund managers regard three years as the minimum for assessing a fund’s performance record.
Beijia Ma, an analyst at Bank of America Merrill Lynch, said having dedicated green bond funds is still useful because they broaden the range of options for investing in green bonds, particularly for investors who do not want to select individual green bonds themselves. “It’s about giving people enough options,” she said.
Dedicated green bond funds also apply a floor that must be invested in green bonds, typically between 50 and 70 per cent, limiting investment opportunities.
Environmental, social and governance focused funds, whose investment approach is guided by ethical and climate concerns, also have to fulfil strict criteria but these are generally less exacting and leave them open to invest in a wider range of debt vehicles.
There is no shortage of green bonds being issued but funds that apply the most stringent criteria would struggle to find investible options, said Sean Kidney, chief executive of the Climate Bonds Initiative, a UK-based non-profit that promotes investments that combat climate change.
A couple of funds, he said, are “struggling to find bonds to invest in”.
