Frustrations dog green bond market

As the green bond market begins to hit its stride with increased issuance and awareness, institutional investors and money managers remain frustrated with a lack of diversification of opportunities.

A number of strategies that invest in green bonds, the proceeds of which are used to fund climate-friendly investments, will reach their three-year anniversary this year — a crucial point for fund buyers, sources said. Green bond issuance has continued to grow, hitting about $160 billion in 2017 vs. about $4 billion in 2010, as has the number of strategies aiming to capture these opportunities.

"When we counted the number of green bond funds outstanding for the first time last June, we identified (those) we felt were true green bond funds," said Alastair Sewell, regional head of fund and asset manager ratings at Fitch Ratings Inc. in London. "Since then we have seen more launches, with a rate that has been quite high relative to (the rest of) fixed income, but we have also seen some diversification in terms of type of fund."

While issuance has increased, institutional ​ takeup has been muted for a number of reasons, although not through lack of trying.

The $231.6 billion California State Teachers' Retirement System, West Sacramento, invests $229.8 million in green bonds; the most recent purchase was in January, said a spokeswoman for the fund. "We continue to be active buyers — if the securities fit our portfolio needs," she said in an emailed comment. "It may seem like we have not been buying as much compared to issuance, but many of the deals lately have been euro-denominated or (emerging markets) focused."

The spokeswoman said while fund executives do not have concerns about the state of the green bond market, "we are feeling a bit impatient there has not been more U.S. dollar issuance lately. It seems like there has been more euro-denominated issuance, which does not fit in our portfolio, although any issuance is positive for the market."

CalSTRS executives also noted more issuance in emerging markets, such as China and India, "which is not index eligible for our portfolio and in markets we normally do not cover. Again, good for the green bond market, just not a fit for us," she added.

Money managers focused on green bonds also have noticed a proliferation of euro- and emerging markets currencies-denominated issuance. My-Linh Ngo, senior ESG analyst at BlueBay Asset Management in London, said: "To date, that currency bias has been a reflection of where the demand has been — most issuers have probably gone for that because their analysis probably shows more receptiveness in Europe. And more emerging market issuers (are) coming forward, looking to issue in currencies attractive to international investors," she said. BlueBay does not run a dedicated green bond strategy.

"It is interesting from a global perspective (that) there is more issuance in euros than dollars — it is the only universe I know of to be the case," said Matthias Dettwiler, head of index fixed income at UBS Asset Management in London.

Sources pointed out a number of other​ frustrations with the green bond market.

The 768.6 billion Danish kroner ($128 billion) ATP, Hilleroed, entered the green bond market in 2017 with an initial 1.5 billion kroner investment.

"The market for green bonds still represents a relatively small share of the bond market, although the market has seen strong growth in recent years," said the fund's 2017 Responsibility Report. "This means that liquidity remains relatively low, resulting in limited options for using green bonds as collateral." Fund executives will monitor the market closely in 2018 "to remain at the forefront of developments."

The 354.9 billion Swedish kronor ($44 billion) AP2, Gothenburg, has been active in the green bond market for almost a decade, said Lars Lindblom, portfolio manager, global fixed income, green bonds. "We were one of the pioneer investors when we made our first investments in The World Bank green bond back in 2008," he said. Investments have since grown, so much so that executives carved out a 1% portfolio allocation to the asset class in 2016.

"AP2's green bond portfolio is expected to continue to grow at a moderate phase. There is a scarcity in green bonds in general and we are active in projects and initiatives to support the green bond market development," said Mr. Lindblom.

Mr. Lindblom said the diversity of issuers is beginning to grow. "Supranational issuers have been the backbone of green bonds development, both measured in issue size and developing reporting standards. Going forward we see more diversification coming from corporate and municipalities. Sovereign green bonds is also a sector where we expect to see more issuance going forward."

Mr. Lindblom said sovereign issuance not only brings volume, but also those bonds "have an important role in making the necessary investments for a transition to a more sustainable economy."

France, Fiji and Nigeria issued green bonds in 2017, following Poland's 2016 sovereign issue, said Rikkert Scholten, portfolio manager, fixed income, sustainable investing at Robeco in Rotterdam, Netherlands.

But there is a further constraint: issuance by sector.

"Despite the growing diversity of issuers, the green bond market remains dominated by financials, utilities, and sovereigns and supranationals," said Joshua Kendall, ESG analyst at Insight Investment in London. "We expect more diversity among issuers, and more regular issuance, will be required for green bonds to become a more significant part of institutional fixed-income portfolios."

And a propensity for transport, power and bank issuers is a reason to be wary, warned Kate Hollis, senior investment consultant at Willis Towers Watson PLC in London. "That may give problems in the context of the rest of the portfolio — if you have a green bond mandate heavily exposed to those three areas, and potentially to emerging markets, it makes it difficult for (the rest of the) bond mandates to be benchmarked against ordinary market cap indices," she said.

"Investors would love more sectors or issuers," said UBS' Mr. Dettwiler. "The more clients and asset managers that follow it, the more money flows in, and more issuance will come."