Lack of diversification in green bond funds is hampering prospects for active funds, according to the ratings agency Fitch.
Green bond fund issuer numbers are limited and concentrated in certain sectors, making it harder for active managers to differentiate their funds from each other and increasing the threat from passive index trackers, the agency said.
Fitch estimates 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.
Funds may choose not to invest in particular sectors irrespective of whether a given bond is green. Some funds mitigate the risk by being able to buy a certain proportion of non-green bonds from issuers that meet broader green criteria.
Investor appetite for the broad sustainable fund sector is strong and the agency estimates assets under management in green bond funds have grown more than 400% since the end of 2015, albeit from a very low base.
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