In a Wildfire World, California Muni Funds are not Created Equal
With a heat wave currently hammering the West Coast and longer term drought conditions being felt across California, the Golden State is entering the heart of 2021 wildfire season with a badly loaded deck. The impact of climate change in the coming years means that same deck will likely deal increasing numbers of losing hands over time. Compounded with the fact that almost 2/3 of the costs of wildfires are covered by state or local government agencies, it is not hard to see how a severe wildfire season might be material to municipal finance, let alone to their respective populations who also bare much of the emotional and financial cost.
Using spatially refined analysis at the municipal bond obligor or securitized mortgage levels, we’ve analyzed the climate risk and social impact of all municipal bonds and all mortgage-backed securities. Then, using the most recent N-PORT filings from each fund, the holdings of each fund were compared and contrasted for ESG-driven risk and impact. For the purposes of the analysis below, the list was culled to municipal bond focused funds, and the relative wildfire risk was analyzed. As one might expect, there is significant clustering given the concentration of wildfire risk west of the Mississippi, and larger inter-state than intra-state social and demographic differences between the funds and their municipal bond issuer cohorts.
The 76 California-specific municipal bond mutual funds and ETFs rise to the top of overall wildfire risk. Conventional wisdom is that the law of large numbers applies, and, from a wildfire perspective, risks at the CA fund level will regress to the mean. After all, with CUSIP counts averaging close to 350 per fund, and even median counts well above 200, there shouldn’t be much variance between funds, and especially at the larger end of that population. In reality, these funds range from between twice and four times the wildfire risk of the average municipal bond fund. There is also significant variance with respect to Social Impact, which covers attributes such as housing affordability, affluence, minority population, health, and education, with the California funds having close to 2 times the range of Social Impact of any other state cohort.
More surprisingly, size does not necessarily help mitigate risk. Of the 12 California funds with more than three times the average fund-level wildfire risk, 5 of them are among largest 10 on a CUSIP-count basis, meaning such funds are very much overrepresented in the higher risk cohort. However, size also doesn’t inherently require outsized risk: one of the largest 5 in terms of CUSIP count is in the lowest risk quartile, proving it can be done. The largest and smallest 10 funds on a a CUSIP-count basis are highlighted below in green and blue, respectively.
For the largest and smallest cohorts, the range in each case is around 150% versus the average muni fund wildfire risk. In contrast, smaller funds show much greater inhomogeneity in terms of Social Impact, with the most significant contributors coming from concentrated poverty and lower existing education components of populations in the respective bond issuers’ jurisdictions. For those wanting differentiation with respect to housing affordability — a big issue in California — that impact score has an average of 77 (out of 100) across the full muni fund universe, ranging from 37 to 92. The range for those California funds is from 85–91, merely confirming what is already known in terms of the need for impact on the state’s affordable housing, while still offering some selectivity within that 6-point range. Again, large and small funds show up at each end of that admittedly compressed spectrum.
Whatever way you cut it, from an ESG perspective there are most certainly choices that can be made.
