Climate Risk Creates Niche Market for Small Bond Funds

(Bloomberg) -- U.S. states and municipalities are facing tough challenges and extra costs in dealing with increasingly extreme weather. Now a niche is emerging for曏 investors who want to invest in projects designed to reduce those risks.

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More and more investors are turning to SMAs, working with advisors to design personalized investment portfolios and putting money into projects designed to reduce flooding and other potential disasters.

"Compared to standard funds or vehicles," says Lauren Kashmanian, director of amortization and responsible investing at Parametric Portfolio Associates, a consulting firm specializing in customized services, "many of the strategies are relatively new. Many of the strategies are relatively new compared to standard funds or vehicles. She has seen a growing demand for these funds from clients interested in projects such as clean drinking water and renewable energy.

At a time when ESG (an investment approach that focuses on environmental, social and governance issues) is under attack by conservative lawmakers, including those in Texas, interest in these funds has increased. But the need to invest in climate change adaptation programs is only going to grow.

According to Municipal Market Analytics, borrowing in the municipal bond market will likely double over the next decade as entities spend money to combat climate change and resume deferred maintenance and infrastructure projects.

Extreme 耑 weather cost the U.S. more than $400 billion last year, according to Bloomberg Intelligence's Climate Damages Tracker. Andrew John Stevenson of Bloomberg Intelligence says more of the cost of dealing with these impacts could shift from the federal government to state and local governments.

Ruth Ducret, a senior research analyst at Breckinridge Capital Advisors and a member of the firm's sustainability committee, said the firm began offering what it calls value-consistency customization at the request of clients. The firm now manages $5.3 billion in sustainable municipal investments.

Breckinridge said the firm is "hands-off" about the use of proceeds or the environmental, social and corporate governance of issuers. Instead, the company screens for projects in underserved communities that need funding to mitigate climate impacts.

In September, the Boston-based firm, which specializes in SMAs, launched three new custom funds, including one for climate risk. The other funds focus on basic service infrastructure and "net-zero" emissions in underserved communities.

"Over the years," Ducret said in an interview, "we've heard that clients are interested in products that are more in line with their values." As a highly rated municipal bond asset manager, we are challenged by the fact that the average credit quality of our investments is AA.

SMAs of all types are growing in popularity, though most have high minimums and are limited to wealthy investors. The assets in these accounts have more than doubled over the past decade, from about $300 billion in 2013 to about $790 billion last year, said Vikram Rai, director of municipal market strategy at Wells Fargo & Co.

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The performance of the so-called green bond sector, which is roughly in line with the broader municipal bond market, is an important consideration because fund managers "have a responsibility to maximize profits, provided that industry penalties are justified, and they (including clients) want to invest in projects that benefit the broader community," Rai said via email They (including clients) want to invest in projects that benefit the wider community".

Wide range of investment needs

The U.S. Municipal Green Impact Index is down about 1.51 TP3T year-to-date, while the broader Municipal Index is down about 1.31 TP3T, according to data compiled by Bloomberg.

"We've seen some pretty good growth in this area over the last four or five years," Marc Uy, manager of AllianceBernstein's Fixed Income Portfolio, said in an interview." The reality is that there are opportunities and communities in need of investment in every state in the country.

Another advantage of SMAs, according to investment managers, is the ability to dig deeper into risk.

"Disclosure has been limited and uneven," says Jonathan Bailey, global director of ESG and impact investing at Neuberger Berman." This means it is possible to identify two issues with similar pricing but different levels of climate risk exposure."

Neuberger helps assess this exposure by utilizing an insurance-linked securities department that underwrites the actual climate risk. neuberger's Municipal Impact SMA, which includes renewable energy projects as well as water and wastewater treatment projects, has performed well and narrowly in line with its benchmarks over the past five years, said James Iselin, director of Neuberger's municipal fixed income division.

Breckinridge uses external data providers to supplement his own research, and AllianceBernstein has established a relationship with Columbia University's Climate Institute.

As investors observe the extreme 耑 weather in their own neighborhoods, Bailey says, they are becoming more aware of it. With municipal bond yields at attractive levels, they are asking, "Can I get a competitive yield with a positive tilt?

-Eric Kane helped write it.

(The spelling of Breckinridge in the eighth paragraph is incorrect).

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