ETFs threaten active green bond funds

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Green bonds suffer a lack of diversification across issuers and sectors that means they are ripe for passive index trackers rather than active managers, warns Fitch Ratings in a new report.

The warning comes as many of the earliest active green bond funds approach a three-year track record in 2018, making it a pivotal year for the product category.

AUM in green bond funds has grown 400 per cent, albeit from a low base, since the start of 2015, but Lyxor’s launch of the first ETF to track investment grade green bonds, the Lyxor Green Bond UCITS ETF, in May threatens managed funds, according to the ratings agency.

The special report, Green Bond Funds Face Diversification Challenge, estimates there are 100 green bond issuers compared to 3,000 names in the broader market leading to concentration risks for active products focussed in the socially-responsible investing sector.

Green bond funds further limit themselves by focussing on low-investment credit in their search for yield with a greater allocation to BBB-rated issuers compared to the green bond index. There are only 22 issuers with this rating in the Bank of America Merrill Lynch Green Bond Index, the report notes.

Issuers are often concentrated in several sectors such as supranationals, utilities and local authorities, while banking and energy are underrepresented.

Some green bond funds are further limited through negative screening. The report points out that this precluded many funds from buying into the €500m green bond issue from Spanish oil company Repsol in May.