Stockholm (NordSIP) – Facing rising interest rates, persistent inflation and fears of an expanding banking crisis in the USA, portfolio managers (PMs) of fixed-income funds classified as Article 9 (Dark Green) under the EU’s Sustainable Finance Disclosures Regulations (SFDR) faced a complex environment during the first quarter of 2023. NordSIP was able to identify ten such funds by Nordic asset manager operating in Sweden during the first quarter of 2023.
Most funds generally outpaced their benchmark by between 0.4% and 0.6%. The performance of the top outlier seems to be driven by the fact that Pareto’s fund invests in high-yield bonds, thus trading risk for higher performance. Meanwhile, while Norron’s performance might have been assisted by the fact that its benchmark had the lowest return of the whole group, the benchmark that Danske Bank compares its fund against had the strongest performance of all.
Beyond macroeconomic concerns and benchmark performances, PMs also faced decreased issuance across Europe, although the Nordic outperformance of the rest of the continent may have assisted in their efforts. Relevant regulatory factors impacting the decisions of PMs have been focused on the EU’s Green Bond Standard. However, some concern is also brewing regarding the appropriateness of Sustainbility-Linked Bonds (SLBs) in the market, although a consensus seems to remain elusive.
Sustainable Bond Market Developments
“Sustainable bond issuance had quite a solid start of the year up until the stresses in the US banking industry started. Green bonds are still what we see the most, although we really encourage the companies to look more broadly and include other project categories in their frameworks. We hope to see more sustainability bonds going forward,” Karin Göranson, portfolio manager of the Handelsbanken Global Obligationer fund explains.
I think the overall sustainable issuance are still below last years at this time but the need for accelerating climate finance should hopefully spur issuance going forward. The new issuance market have probably suffered a bit from this quarters interest rate volatility. In our Hållbar global obligation, we try to look for new themes where water has been one area of focus. We aim to diversify the sustainable projects we finance and scan for different themes, geographic exposure and new opportunities,” Göranson continues.
“In addition to inflation and central bank actions, we have seen an increased focus in sustainability on issues related to social and, above all, governance. We also see that the rate of issuance of green bonds is increasing as well as the portfolio companies are starting to report on taxonomy,” says Jan Törnstrand, Portfolio Manager of the Norron Sustainable Preserve fund. “Biodiversity is an emerging theme which many companies are incorporating in to their risk assessments. Within Norron, we focused on reducing credit risk exposure and increasing interest rate risk exposure during the first quarter as under 2022 as well,” Törnstrand adds.
“The ESG labelled debt was one of the dominating themes and forces on the sustainable fixed-income markets during 2023Q1. According to Bloomberg, issuance has increased by 12% in comparison to Q1 2022 leading to more opportunities for the sustainable funds. Further, regulation became stricter with the last part of SDFR that came into force beginning of Q1. While there is still debate on the meaning of “sustainable investment”, the ESG labelled debt is a good financial tool as it clearly maps proceeds and targets to green development,” Stefan Ericson, PM of the Pareto ESG Global Corporate Bond fund.
According to Jyri Suonpää, PM of the Ålandsbanken Green Bond ESG fund, one of the dominant trends in the market was the “increased supply in SLBs. But the most decisive themes should always be the reduction of carbon dioxide emissions and biodiversity, nothing else. They decide whether the goals that are being sought are achieved.”
Regulatory and Political Developments
The most recurrent regulatory and policy themes mentioned as an important development during the first quarter of 2023 was the development of the EU’s green bond standard and the latest onthe EU Taxonomy of sustainable activities.
“We have not really seen a clear trend or theme driving the markets so far this year but the provisional agreement on an EU Green bond standard could begin to have an impact going forward. The drive for issuers of issuers to start reporting taxonomy alignment of their use of proceeds will become more relevant,” say Gustaf Linnell, PM at the Storebrand Grön Obligation Fund. “We are wating for the Taxonomy data from annual reports to come in,” Gustaf Tegell PM of the Enter Klimatfokus Ränta fund agreed.
“An important event in Q1 has been the preliminary agreement between the EU Parliament and the Council on the EU Green Bonds (EuGB) Standard, the first standard in the world for green bonds. The EuGB standard is in line with taxonomy legislation that defines which economic activities can be considered environmentally sustainable, and is hoped to become the “gold standard” for sustainable investments in the future,” Mariann Stoltenberg Lind, PM of the Odin Sustainable Corporate Bond fund.
“I believe the most dominating themes have been the agreement reached in EU on the Green Bond Standard, the climate tilting of the ECB’s corporate bond programme (€350—400 billion) and the presentation of the Green Industrial Plan by the EC. Furthermore we have seen biodiversity continue to climb up on the agenda with multiple new actions supporting this,such as the Taskforce on Nature-related Financial Disclosures (TNFD) framework,” adds Kristian Rønde, PM of the Danske Bank Eur Corp Sust Bond fund.
Are SLBs Fit for Article 9?
The increased issuance of SLBs could clash with market perceptions and EU regulations. “SLBs seem to be at an inflexion point where there seems to be a skepticism and questions regarding credibility around targets. We think it’s a good instrument for companies trying to transition to be more sustainable but is requires a bit more analysis,” Göranson argues.
However, others were not quite as optimistic. “During the first quarter of the year, we realised that we cold no longer buy SLBs as an Article 9 fund due to the ‘Do No Significant Harm’ (DNSH) rule in SFDR,” Cecilia Dahlstedt Myrgård, PM of the Captor Dahlia Green Bond fund, which focuses on investment grade investments. “As we interpret the SFDR, an investment cannot be classified as sustainable if it does not meet the SFDR’s requirement to “do no significant harm”. It then becomes difficult for us Article 9 Portfolio managers to ensure that our investment does not cause any significant damage when we finance the entire company. When it comes to green bonds, we can refer to the specific green projects (use of proceeds). This is our interpretation and I know that other fund managers may make a different assessment. It’s an interesting question that should be addressed to get more clarity on how SLBs can/should be viewed according to the SFDR,” Myrgård adds.
Performance and Duration Dynamics
Some of the PMs highlighted the impact of interest rate duration in the performance of their funds. Linnell assessed Storebrand Grön Obligation fund’s performance as “in line compared to peers with similar financial profiles in the Nordic market. Compared to our targets, we have performed well. This is due to an underweight in duration but also a good performance for the corporate bonds within the portfolio.”
“We have a different strategy than most Article 9 funds, with low-interest duration and focus on quality corporates. Performance relative to other funds with this strategy performance for the first quarter were somewhere in the middle. But last year’s performance was much better than most peers,” Enter’s Tegell explains. “The fund’s performance is in line with the yield in the fund. But we strive to deliver a total return above the yield so somewhat below target. We came into the year with a solid portfolio. We increased beta exposure in the beginning of the year and captured strong market performance in January and February. Market volatility in March shaved off some of that performance even though drawdown was limited,” Tegell adds.
“We are satisfied with this performance in absolute terms and relative to benchmark. Relative to peers is more difficult as there can be large variations in the investment universe for the different funds. Our strategy has a focus on the SDGs, which makes it more broad in nature. Other Article 9 funds might have a strict environmental or social focus making their investment universes significantly different from ours. Furthermore funds can have different duration targets. Therefore comparison between funds can be difficult,” Danske Bank’s Rønde says. “The absolute performance of the fund and the benchmark have been driven by the small decrease in rates we saw in underlying interest rates in the period. The outperformance of the fund relative to it’s benchmark have been driven by security selection and the funds overall risk position,” Rønde continues.
Performance and Interest Rate Movements
Interest rate changes and market volatility came up as a recurring cause of the performance of the different funds. “In terms of market conditions, the bond market has been marked by market turmoil in the first quarter of 2023. There have been wide fluctuations in market rates and credit margins, particularly during the banking turbulence we witnessed in March. There have been fewer new issues than usual, and thus fewer green bonds in the primary market. This has reduced access to investments that meet our ESG criteria and has led us to be more active in the secondary market to find good and sustainable bonds for the fund,” Odin’s Lind noted.
“We are pleased with the return and have outperformed our benchmark index (1.78% vs. 1.23%). Not long ago, we had a zero interest rate regime. The interest rate level has now risen, resulting in a better return on the fund than earlier. Despite challenging market conditions, we have also generally had good returns on credit bonds. When it comes to excess return relative to the index, the choice of individual bonds (stock picking) has contributed to this,” Lind added.
Glad to have outshone some of its close competitors, Captor’s Myrgård highlighted her fund’s 0.5 percentage point outperformance vis-à-vis Bloomberg MSCI Euro Corp Green Bond hedged to SEK benchmark. “Our target is to perform a little better than our benchmark so we are happy about that. Compared to our Swedish peers, we have longer duration, more interest rate risk, which explains the good performance during Q1 2023 since yields came down in 5-year SEK swaps during the quarter. Compared with our benchmark index, we have more Swedish credits in Dahlia and they have outperformed European credits during the first quarter 2023,” Myrgård adds.
“No fixed income fund is exactly like any other and we have a flexible mandate within Nordic IG with elements of Nordic HY,” Norron’s Törnstrand says. “Due to the fact that we have more interest rate risk than average, the fund is more sensitive during volatile fixed-income markets. For parts of the quarter, we were at the top in Morningstar’s category, but we have slipped back a bit, but we are convinced that we will perform better than average in a slightly longer perspective,” Törnstrand adds.
Törnstrand attributed the performance of the Norron Sustainable Preserve fund “to tighter credit spreads and interest rate movements that have made a positive contribution.” Törnstrand assessed the fund’s performance as “in line with our targets. But we expect that our strategy will outperform our peers in the longer run.
Performance and Security Selection
“We focus on our own performance and I guess the mandates differs a bit between different funds. We performed better than the benchmark, so an okay performance in a quite volatile market. The performance [of the Handelsbanken Global Obligationer fund] was driven by our choice of security selection,” Handelsbanken’s Göranson argues.
The fund’s performance is measured against a peer group with similar profiles (Article 9 and High Yield Fund). The Pareto ESG Global Corporate Bond fund is considerably ahead on a rolling 12 months basis,” Pareto’s Ericson says. “The fund has done slightly better in that shorter time span than our target returns and has therefore raised our target returns for 2023. Ericson attributed this performance to a “good combination of portfolio selection and slightly cautious risk allocation,” Ericson concludes.