Fund managers revamping bond models to capture new risk

investmentnews.com:

A growing number of asset managers are reassessing bond values tied to real assets, as a spike in the frequency of flash floods, fires and storms hits conventional pricing models.

Mitch Reznick, head of sustainable fixed income at Federated Hermes, says climate risk is a key reason why the investment manager is now underweight real estate credit. Jonathan Bailey, global head of ESG and impact investing at Neuberger Berman Group, says he’s increasingly looking at whether issuers have enough capital to deal with the fallout of climate change. And analysts at Barclays say nature-related risks are being mispriced across sovereign bond markets, and will ultimately trigger downgrades.

“There are often times where two otherwise very similar looking investment opportunities have very different physical risk profiles from a climate perspective,” Bailey said in an interview. A bond issuer that’s been able to protect itself from physical climate risk is likely to be the better investment over time, he said.

The credit ratings industry has yet to figure out how best to incorporate climate risk in its models, so fixed-income investors are largely having to rely on their own assessments to navigate the new landscape they face. According to the Institute for Energy Economics and Financial Analysis, bond investors can’t turn to credit ratings for a useful evaluation of environmental risks.

In a recent report, the IEEFA said that inside the biggest ratings firms, “alarm bells have been sounding for months.” But those internal warnings have gone largely unheeded, which is concerning, according to Hazel Ilango, an energy finance analyst focused on debt markets at IEEFA. 

As large swaths of the planet get battered by extreme floods,