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Art9 Bond Funds Rule 2023 with Duration, Fixed Rates and Real Estate

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Stockholm (NordSIP) – The fourth quarter of 2023 was marked by a continued improvement in the performance by the Nordic fixed-income funds with a global investment focus classified as Article 9 (dark green) under the EU’s Sustainable Finance Disclosures Regulation (SFDR), available to retail investors in Sweden.

The improvement was due to the continued perception that monetary policy had shifted to a more accommodating stance by the end of the third quarter, thanks to a deceleration of inflation. Following the last rate increase by the US Federal Reserve at the end of July, the fourth quarter of 2023 was the first three-month period since 2021 that did not witness a rate hike by the American central bank. On the other side of the pond, the ECB followed suit, have held rates still since the end of September, the first quarter it did so since starting on an upward rate path in the second half of 2022.

Taken together with the improvement that had already started in the third quarter, these trends allowed most fixed-income funds to finish the year in positive territory.To better understand how these developments affected sustainable investors during the last quarter of the year and for the full year, NordSIP reached out to the portfolio managers of 13* 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. High duration, fixed rates, real estate and the automotive sector stand out as the main sources of success for the funds we surveyed.

 

A Perfect World for Bond Funds

Portfolio managers unanimously agreed about the importance of the change in the monetary policy environment but added some colour to the effect this had on their environment. Gustaf Linnell, portfolio manager of the Storebrand Grön Obligation fund, is sanguine about the end of 2023. “In short, I would say that Q4 was the quarter that marked the end of the hiking cycle. There was a significant rally in rates all over the curve. The risk-on environment made credit bonds rally as well. It was a perfect world for bond funds with duration.”

Kristian Rønde Hefting, portfolio manager of the Danske Bank Eur Corp Sust Bond fund, argues that slowing inflation “combined with a still strong labour market and the absence of a severe recession, fuelled a strong rally in interest rates and (albeit to a lesser degree) credit spreads.” Cecilia Dahlstedt Myrgård, portfolio manager of the Captor Dahlia Green Bond fund, highlights swap rates and credit spreads. “Looking at the whole year, interest rates have come down a lot. The SEK 5-year swap rate was down from 3.15%-2.37%. The credit market also performed strongly in Q4 with credit spreads tightening a lot. Both which is great for fixed income fund performance,” Myrgård says.

Gustaf Tegell, portfolio manager of the Enter Klimatfokus Ränta fund, notes that these macro trends had a direct effect on fixed-income markets, leading to “falling interest rates and a risk on” sentiment that allowed investors to consider riskier assets. Jan Törnstrand, portfolio manager of the Norron Sustainable Preserve fund, agrees, noting that the more accommodating stance was particularly positive for real estate companies in Q4.

“The fourth quarter saw something of a turnaround. From October’s markets being quite depressed with interest rates rising and credits trading wider, the market turned upside down. Almost a little unlikely in hindsight. In November and December, global interest rates fell and credit spreads tightened. Demand for more risky credits was massive, large inflows in credit funds and low new issuance in December all contributed to tighter spreads,” adds Karin Göransson, portfolio manager of the Handelsbanken Global Obligationer fund. Her colleague, Klas Wennerstein, portfolio manager of the Handelsbanken Hållbar High yield fund, echoes this sentiment. “The 4th quarter started with a weak sentiment in the market. All in all financial conditions were tightening. Rates and credits preads were up, the equity market was weak.

Looking ahead, the portfolio managers of the ODIN Sustainable Corporate Bond fund note that the “fixed-income market is pricing in several interest rate cuts in the coming year, but there are no expectations that we will return to the zero-interest rate regime from which we came. Interest rates, and not least real interest rates, have reached a level where there are good return opportunities in the fixed income market going forward.”

Fixed Coupons Helped Navigate a Volatile Market

Given this changing market mood in the second half of the year, asset managers note that fixed coupons did well. Julia Stålbro, portfolio manager of the Öhman Grön Obligationsfond, explains that her fund “favoured bonds with a fixed coupon, given that interest rates and credit spreads were rising. With rates falling during the fourth quarter, bonds with a fixed coupon performed very well.”

Henrik Rosencrantz, portfolio manager of the Ruth Core Nordic Credit fund, shares this view. During the fourth quarter, our best-performing bonds had fixed rates. Looking at the full year, [debt recovery company] Intrum was a major contributor, thanks to a coupon of over 10% topped by a positive price move.

Green bonds were dominant, but not exclusive, with asset owners such as ODIN pointing to their holdings of social bonds and sustainability-linked bonds (SLBs) as a source of return.

Duration for the Win

Duration was another factor that was fuelled returns. “Having duration was clearly a winning strategy in Q4,” Storebrand’s Linnell says, reiterating his earlier point. Captor’s Myrgård agrees. “The enormous movement in market rates led funds and benchmark indices with a lot of duration to perform well. The benchmark index we use has a bit longer duration, which explains the outperformance to Dahlia green bond in q4 and YTD 2023,” she explains.

Öhman’s Stålbro, too, echoes this view. “After the summer, the fund started to add duration and credit risk gradually, which led to outperformance relative to the index. Relative to its index, the fund had a higher duration during the quarter, which was beneficial in a period of falling interest rates,” she says.

Real Estate Goes Up

Portfolio managers also agreed about the positive effect of this more tranquil financial environment on the real estate sector. “Falling interest rates and tightening credit spreads contributed significantly to performance during the end of 2023, which particularly benefited the Swedish Real Estate sector. This was also our best-performing sector together with the insurance sector,” says Charlotte Lind, portfolio manager of the SEB Climate Focus High Yield Fund.

“We are very satisfied by the excess performance of the fund, which was driven by security selection within a broad range of companies. Our green and social bond investments in the banking and property sectors contributed especially to the excess returns. We continue to be overweight these sectors going into 2024,” Danske Bank’s Hefting explains.

The logic for the success of real estate can be understood by the sector’s sensitivity to interest rates. Öhman’s Stålbro notes that “interest rate-sensitive sectors such as real estate saw better performance during the [fourth] quarter following a longer period of time with elevated credit spreads.”

Gustaf Tegell, portfolio manager of the Enter Klimatfokus Ränta fund, illustrates this trend with examples. “All sectors contributed, but real estate bonds had a very good return, with bonds from Atrium Ljungber, Kungsleden, Castellum and Balder providing returns of 10-15%. Bonds from the insurance company Tryg Forsakring and airport operator Swedavia also returned around 10%,” he says. According to Storebrand’s Linnell, lower-rated real estate companies benefitted most from the easing conditions. “On a segment basis, the real estate sector had a good performance during Q4. A major part of the BBB-segment in this sector have had a hard time coping with higher rates and now with falling rates these bonds have had a great performance,” he adds.

According to Jyri Suonpää, portfolio manager of the Ålandsbanken Green Bond ESG Fund, this dynamic is particularly important for fixed-income sustainable investors. “The recovery of the real estate and construction sector in Q4 clearly affected the returns of the ‘green funds’ and the index. The effect was clearly positive for funds like ours, with a strong Nordic weight and focus. The real estate and construction sector is the most active issuer of green bonds.”

The relevance of this sector is also visible to those who choose to underweight it. “In the second half of the year, the real estate companies performed very well in euro and SEK.  We have actively chosen to have a low proportion of green bonds from the real estate sector because we find other sectors financing more interesting projects with potentially higher impact. The RE sector outperformed many other sectors during Q4, contributing to the fund’s lower performance vs benchmark at the period,” Handelsbanken’s Göransson explains.

Aside from his shared appreciation for investment-grade companies with a focus on sustainability and long-term bonds, especially from real estate companies, Jan Törnstrand, portfolio manager of the Norron Sustainable Preserve fund, also highlights his funds’s ability to avoid bad investments. “The main reason for our steady performance was that we didn’t have any really bad performing bonds in the portfolio, like SBB, Heimstaden AB or Viaplay, among others. All bonds in the fund actually gave a positive return year-to-date,” he argues.

Defensive Positioning

Several portfolio managers highlighted the importance of defensive positions for their fund’s performance. Göransson says that during the end of the quarter, the fund was positioned more defensively regarding credit risk and loss relative to its benchmark, while noting that over the whole year, the fund’s choices contributed positively to the return. “Humlegårdens 2027 green bond, VW 2028 green bond and Caruna OY 2028 green bond were among the Top 5 contributors to the fund’s performance,” she explains.

Öhman’s Stålbro notes a similar trend at her end. “Compared to its index, the fund has a larger exposure to BBB/BBB-rated real estate, which outperformed higher-rated real estate bonds during the period. The fund remained very selective in its investment during the first half of the year and favoured companies with better credit quality and companies that can operate both in a low and high-interest rate environment,” she says.

The auto sector was also important for Handelsbanken’s Wennerstein and his fund’s defensive positions. “Much of the performance comes from more defensive positions among BB-ratings. For example, many of the subsuppliers in the auto sector, like Forvia SE and ZF Finance GmbH, have performed well, as well as the Spanish bank, Banco de Credito Social Cooperativo, among others. The defensive trade worked well until the start of November, when the rally started. During the last two months the positions in Republic of Colombia:s Social bond and the SLBs in  Picard Groupe SAS that was the top performers.

For their part, the portfolio managers of the ODIN Sustainable Corporate Bond fund pointed to their focus on banks, energy-efficient buildings, renewable energy production, the utility sector and the development of electricity grid infrastructure.

The Regulatory Environment – COP28 and the EU GBS

Danske Bank’s Hefting also notes the importance of COP28. “On the sustainability side, the main event of the 4th quarter was the COP28, where countries finally agreed to “transition away from fossil fuels”, although many were hoping to see a commitment to a full phase-out. Furthermore, one could have hoped for the deadlock on an international carbon market to have eased during the discussions, but that was not the case,” Hefting says. SEB’s Lind agrees, noting that the closing of the COP28 with the words “beginning of the end for fossil fuels” was a significant step forward in the sustainability agenda.

On the other hand, Ålandsbanken’s Suonpää highlights the importance of the approval of the EU Green Bond Standard. “The most clearly important event and theme during Q4 was the approval to the EU GBS Standard, ‘The Golden Standard’ fair to say. The long-awaited EU Green Bond Standard was approved in October, which is set to apply from the end of 2024,” Suonpää tells NordSIP.

The regulation lays down uniform requirements for issuers of bonds that wish to use the designation ‘European Green Bond” or ‘EuGB’ for their environmentally sustainable bonds. EU GBS is based on current market best practices and is designed to be compatible with existing ICMA GBS. However, it also goes further in certain key aspects, including the requirement for full alignment of funded projects with the EU Taxonomy and establishing a regime for the registration and supervision of external reviewers. European Green Bond issuers will be required to disclose considerable information about how the bond’s net proceeds will be allocated in accordance with standardised templates, including alignment with the EU Taxonomy,” Suonpää concludes.

 


*Although we spoke with the fund managers of 13 funds, annual data was only available for 11 of these. This is because the Swedank Robur Climate Bond High Yield fund and the SEB Climate Focus High Yield fund were launched in September 2023 and March 2023, respectively, and as such were unable to provide data for the whole of 2023.  According to Karin Beltzér, portfolio manager of the Swedank Robur Climate Bond High Yield, “the fund was created and launched on the 7th of September 2023 by transforming the Article 8 fund Swedbank Robur Corporate Bond Europe Mix. The former fund was a 50/50 Investment Grade/High Yield mandate, with a duration capped at 1.5 years.”

 

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