Green Bond Funds Face Diversification Challenge, Fitch Report

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07 Aug Green Bond Funds Face Diversification Challenge, Fitch Report

Diversification is the main portfolio management challenge for green bond funds as issuer numbers are limited and concentrated in certain sectors, Fitch Ratings report. The size of the investible green bond universe depends on the specific definitions and characteristics of each fund, but Fitch estimate there are around 100 issuers, compared with the 3,000 names in broader market indices. Many of these issuers are in a handful of sectors, such as supranationals, utilities and local authorities, while sectors like banking and energy, which represent a large part of the broader bond market, are currently under-represented.

The limited number of issuers creates concentration risk relative to other broad market corporate bond funds, which can be exacerbated by the additional investment criteria imposed by most funds, or by a preference for bonds at a certain point on the credit-quality spectrum according to Fitch.

Investor appetite for the broad sustainable fund sector is strong and Fitch estimate AUM in green bond funds have grown more than 400% since the end of 2015, albeit from a very low base. However, the launch of a green bond ETF by Lyxor earlier this year could hamper the prospects for managed funds. The trend of passive funds cannibalising active funds has been clearly established in the broader market; in the green bond sector limited diversification makes it harder for managed funds to differentiate themselves from the index, and the small size of the sector creates the risk of active funds being crowded out.

With these risks in mind, according to Fitch, 2018 could be a pivotal year for the future development of the green bond fund sector as several funds will achieve a three-year track record, which is the minimum required before many institutional investors will consider investing.

Full report from available here.