Stockholm (NordSIP) – The third quarter of 2023 was marked by interest rate increases, hints at a potentially more accommodating monetary policy environment and geopolitical turbulence. To better understand how these developments affected sustainable investors, NordSIP reached out to the portfolio managers of 12 Nordic fixed-income funds classified as Article 9 (dark green) under the EU’s Sustainable Finance Disclosures Regulation (SFDR), available to retail investors in Sweden.
Monetary policy conditions and opportunities in sustainable fixed-income markets, Nordic real estate, regulation and exchange rate dynamics were the dominant topics raised by fund managers surveyed on this occasion. Most funds provided positive returns, be it on an absolute or on a relative basis. On a relative basis, except for the Danske Bank Eur Corp Sust Bond fund, Pareto ESG Global Corporate Bond A fund and the SEB Climate Focus High Yield fund. Ålandsbanken was the only fund with a negative absolute performance, which it attributed to the fact that the fund is denominated in euros rather than SEK, which was the currency in which performance was calculated for all funds and benchmarks. The euro fell from SEK11.82 at the end of June to SEK11.77 at the end of September.
From a market structure perspective, the third quarter of 2023 saw the launch of two new funds. The merger of Navigera and Navini, both owned by Max Matthiessen one of Sweden’s leading life and non-life insurance brokers, led to the creation of the the Ruth Core Nordic Credit fund. At the end of the quarter, Swedbank Robur also launched the Swedank Robur Climate Bond High Yield fund. The fund was launched too late in the quarter to warrant inclusion in this review but will be included in the upcoming fourth quarter review.
Economics and Monetary Policy Dominate
Macroeconomic and monetary policy concerns were the priority for fixed-income managers. During the third quarter of the year, fixed-income markets were dominated by interest rate rises. In the Eurozone, the ECB increased rates twice, from 3.5% at the start of the quarter to 4% by the end of September. In the USA, the Fed increased rates once, at the end of July, by 25 basis points (bps), leading the federal funds rate to fluctuate between 5.25% and 5.5% by the end of the quarter. Sweden’s Riksbanken increased its key interest rate twice, both times by 25bps. At the start of July rates were increased from 3.5% to 3.75%. Then, at the end of September the Swedish central bank increased rates once more from 3.75% to 4%.
“The market was dominated by a volatile interest rate period where rates moved up while we the economy is slowing down,” Stefan Ericson, Portfolio Manager of the Pareto ESG Global Corporate Bond A fund, told NordSIP.
“Inflation and interest rate hikes have probably peaked, but the big question is how long policy rates will be kept at high levels for the economy to weaken and underlying inflation impulse to be clearly dampened,” Julia Stålbro, portfolio manager of the Öhman Grön Obligationsfond commented.
An End to Interest Rate Hikes?
However, the focus was not just on the rate hikes but on their momentum. Indeed there seems to be some expectation that the trend of interest rate increases to have ended.
“In September we also saw what could be the final rate hike from ECB. The ECB implemented a 25 bps hike taking its benchmark deposit rate to a 20-year high of 4%. The real surprise was however the rhetoric used at the meeting. ECB is taking a break and will observe how inflation and growth unfolds from here. The pause seems to be motivated by the Eurozone’s surprisingly poor performance during the summer,” Danske Bank’s Hefting added.
“We are seeing the ending of higher interest rates from central banks, but high volatility is still the theme but we expect lower as the rates comes down,” Sebastian Uddén, Portfolio Manager of the Norron Sustainable Preserve R fund explained.
The view was not unanimous. Indeed, Charlotte Lind, Portfolio Manager of the SEB Climate Focus High Yield fund, was less sanguine. “The 3rd quarter saw continued rate hikes by central banks and higher interest rates despite signs that inflation is slowing down. Higher rates for longer is the message by central banks. Credit markets held up well and earnings reports were mostly strong,” Lind argued.
Issuance, Greenium, SLBs and Regulation
Focusing more on developments and opportunities in sustainable fixed income markets, managers discussed bond issuance, greenium developments, sustainability-linked bonds (SLBs), regulation, the state of Nordic credit, and conditions in the real estate market.
The market for sustainable bonds also provided a range of new investment opportunities. “After the usual quiet July and August we saw new issues pick up again in September adding to what looks to be a record year when it comes to new issues in the EUR IG credit market. The EUR IG labelled bond market (Green, Social, Sustainable and Sustainability-Linked bonds) are also delivering a solid year in terms of issuance although at a slightly lower level than what we saw in 2022. Green bonds are still the most dominating type making up 75% of issuance,” Kristian Rønde Hefting, Portfolio Manager of the Danske Bank Euro Corporate Sustainable Bond Fund, said.
Focusing on returns, Jyri Suonpää, Portfolio Manager of the Ålandsbanken Green Bond ESG fund noted that they fell steeply. “During Q3 the greenium continued to decrease and, especially in strong IG bonds, falling down almost to zero. In the weaker part of IG, and in HY, it is still between 2-7 bps, but it is gradually decreasing there as well. Therefore, the price benefit analysis for issuing ESG bonds in any category is systematically and consistently is more or less non-existent,” Suonpää argued.
SLBs are still an important consideration. “In the Nordic market, there is still a lot of discussion about SLBs and there have been several different gatherings and discussions around them. There is still disagreements to whether it is a good sustainable instrument or not,” noted Karin Göransson, Senior Portfolio Manager of the Handelsbanken Global Obligationer A1 Fund. “Otherwise, I think there has been a increased focus on Scope 3 emissions. We have had several conversations with different companies on that topic. We see it as necessary for the companies to include Scope 3 emissions in their SLB framework if its accounts for at significant part of the companies total, ” Göransson added.
“Another significant thing during Q3 was the approval of the EU Green Bond Standard. However, it remains to be seen what the real market impact will be when it comes into use in about a year. The good thing was that it does not significantly differ from ICMA’s GBS standard, which is already widely used, really only the reporting requirements for companies are increasing, which of course is a good thing for investors,” Suonpää, told NordSIP.
Peripherally, but relevant to green bond stands, Hefting also focused on GHG emissions. “The Science-Based Target initiative (SBTi) published their yearly monitoring report in August. The SBTi have become the main GHG-emission reduction target validator in the market and the report provides a status on how many companies are setting Paris Aligned and Net Zero targets. Unsurprisingly the SBTi is very busy validating targets and have a large backlog of companies requesting target validation. The largest share companies setting targets are in Europe with Asia experiencing the largest growth. More than 4.000 companies and financial institutions have set or are committing to setting science based targets by end 2022. The report indicates that companies setting targets are reducing emissions at a higher pace than companies not setting targets,” Danske Bank’s Hefting said.
Real Estate Market Considerations
In the Nordics, credit market conditions, especially in the real estate market were one of the main topics of concern for portfolio managers. ”For me, inflation and rate moves, as well as the problem and opportunities in the Nordic RE sector were the dominant themes during the third quarter,” Henrik Rosencrantz, Portfolio Manager of the Ruth Core Nordic Credit fund said. Gustaf Linnell, Portfolio Manager of the Storebrand Grön Obligation A fund, agreed. ”During the quarter the main theme was tighter credit spreads over all sectors with most tightening in the real estate sector,” Linnell argued.
”Activity in the Nordic credit primary market picked up following a slowdown during the summer while secondary trading remains relatively slow. With outstanding bond volumes down, a slightly more positive sentiment in the real estate sector following bond issuance from Fabege and Castellum, and investors coming into the period with cash on hand, we have seen credit spreads tightening during the third quarter,” Julia Stålbro, portfolio manager of the Öhman Grön Obligationsfond
”The real estate sector in Sweden performed very well after the summer holidays. The market seemed to think that the worst was over. We do not really agree with that. But credits preads for these companies came down quite drastically due to large buys from our peers,” Cecilia Myrgård, Portfolio Manager of the Captor Dahlia Green Bond fund explained. “We started buying some more real estate bonds during the quarter and extending the duration, from floaters to fixed (from 2,0 to 2,6 years during the quarter and decreased the credit risk as well during the 3rd quarter),” Uddén added.
The relevance of real estate markets for sustainable fixed income was previously noted in the latest review of sustainable bond issuance, where evidence of its relevance was particularly prominent in Sweden.
Performance Drivers
Active management, carry and duration were an important driver of manager returns. “Carry higher cash return are the positive contributions, but duration provided slightly negative performance contribution. Also on a positive note quality companies with strong sustainability characteristics perform well,” Pareto’s Ericson explained. “The performance vis-à-vis the benchmark came mostly from our active positioning in duration,” Göransson agreed.
“The fund’s YTD outperformance compared to benchmark have mainly been driven by security selection within companies in the property and consumer non-cyclical sector as well as the banking sector. Furthermore the fund’s overall risk exposure have contributed positively as well,” Danske Bank’s Hefting added.
“We had positive absolute returns during the quarter. In relative terms, we have been a bit more defensive position than our index. Our overweight allocation to the renewables sector made a positive contribution to performance as well as the banking sector. Insurance companies and Swedish real estate (approx. 6% of the portfolio) underperformed during the quarter. As previously mentioned, it should be noted since the fund article 9 and has a Nordic focus the key characteristics like sector and country allocation varies as well as duration and spread from time to time so performance is best measured over a longer period. As previously mentioned, it should be noted that since the fund is classified as article 9 and has a Nordic focus and the benchmark is a Pan-European high yield index, the key characteristics like sector and country allocation varies, as well as duration and spread from time to time, so performance is best measured over a longer period,” SEB’s Lind explained.
Norron’s Uddén pointed to coupons and lower interest rates as the drivers of his fund’s performance. “Performance was very widely spread over many holdings during the quarter,” Ruth’s Rosencrantz commented. Storebrand’s Linnell focused on the contribution of credit bonds.“Main attribution to absolute performance was the spread-tightening component for the credit bonds in the portfolio,” Linnell said.
The previously highlighted real estate dynamics also played a role in fund returns. “Performance was driven by the fact that we still have some real estate bonds in our portfolio. We were able to outperform our benchmark because they don’t have these type of bonds in their index,” Captor’s Myrgård explained. “Higher rates had a negative impact on the fund’s performance during the 3rd quarter while tighter credit spreads had a positive impact. With a slightly more positive sentiment in the real estate sector, the fund’s holdings within the sector outperformed during the period. The fund’s outperformance relative index can mainly be attributed to it having a higher running yield,” Öhman’s Stålbro commented.
Ålandsbanken’s Suonpää focused on exchange rate dynamics. “Favorable positioning of the fund on the credit and interest rate curve, not so much ESG factors. The strengthening of the Swedish krona during the quarter also had a positive effect on the fund’s return in SEK. Suonpää was keen on emphasising the role of interest rates in his fund,” Suonpää said.
“Moreover, the nominal value of all the fund’s investments is in euros, and all cash flows are in euros. Every investment is made only in euro-denominated instruments, and interest and capital are always paid only in euros. There is not a single SEK-denominated investment in the fund. Therefore, the development of the SEK share series, to the extent that it differs from the Euro share series, results only and only from the development of the Swedish krona. Which is of course something that the portfolio manager cannot influence (and of course I don’t speculate on currency itself), and therefore does not say anything about the success of the portfolio management per se,” Suonpää concluded.
