On occasion, the managers launching exchange-traded funds are significantly ahead of the trend. The growth of investing in green bonds and fixed-income strategies weighted by environmental, social and governance factors looks to be one of those times.
While ESG investing in global equities has clearly emerged for asset owners and money managers, it is far more latent for fixed income. Only recently have a handful of pension funds in Japan, Norway and the Netherlands announced their intentions to approach their portfolios more holistically with regards to responsible investing, while large European insurers (Swiss Re, Allianz SE and AXA) are focusing on ESG in fixed-income portfolios.
It's only been 4.5 years since MSCI Inc. and Barclays Risk Analytics and Index Solutions Ltd. (now part of Bloomberg LP) launched 27 fixed-income ESG indexes. In those indexes, bonds were categorized by currency, issuer type, geography/currency, and screened or weighted by business, ESG risk or rating.
Currently, the ESG fixed-income category for ETFs counts just five funds from four issuers and $83 million in assets, including the Sage ESG Intermediate Credit ETF from first-time issuer Sage Advisory Services Ltd. Co., which launched on Oct. 31. Based on the current emphasis and rhetoric around ESG investing in equities, these ETF issuers are placing an early bet that fixed-income assets are soon to follow.
Martin Kremenstein, head of NuShares at Nuveen, part of TIAA, is staking the future of his business on the ESG trend, introducing eight ESG-focused ETFs in 2017. "Through reverse inquiry, we learned that there were some investors looking for a U.S. aggregate ESG bond product," he said.
The NuShares ESG U.S. Aggregate Bond ETF launched in September holds $40 million at a 0.2% annualized expense ratio. BlackRock Inc. also offers the iShares ESG USD Corporate Bond ETF at 0.18% and the iShares ESG 1-5 Year USD Corporate Bond ETF, both based on Bloomberg Barclays indexes.
"In 2014, when we first identified this opportunity, the green bond market, a particular subset of ESG fixed-income investing, was too small," said Bill Sokol, product manager at Van Eck Associates Corp., which launched the VanEck Vectors Green Bond ETF in March. The ETF, which tracks the S&P Green Bonds Select index, costs 0.4% and has $10.7 million in assets. The fund is largely defined by the available debt issues, with a heavy weighting to the euro and government-related bonds. A global aggregate product, the index's currency weighting is due to the eurocentric nature of the green bond market. S&P's index only includes bonds certified by the non-profit Climate Bonds Initiative, which estimates 2017 certified issuance at $130 billion, compared to $82 billion in 2016.
More broadly, the International Capital Market Association's Green Bond Principles outlines voluntary guidelines for green bonds. The securities must define "Green Projects" in their use of proceeds, define the process by which the issuer assess environmental sustainability objectives of the funded project, details on how the proceeds are managed, and a mechanism for reporting.
In an October article, Sara Bernow, Bryce Klempner and Clarisse Magnin at McKinsey & Co. argued that ESG investing has moved from "why" to "why not" for institutional investors, yet they reiterate the challenge investors face in defining their approach to the market.
For years, ESG has been deemed concessionary — sacrificing return to express some principles-based approach to a market — and that continues to be a concern for some investors. An institutional investor survey released in October by Schroder indicated 42% of North American institutions surveyed still held that belief.
In 2016, however, Albert Descleé and Lev Dynkin, managing directors in the quantitative portfolio strategy group at the Barclays PLC research division, released a study to the contrary with regard to ESG fixed-income investing. Screening on both MSCI and Sustainalytics data, the authors ranked the governance and environmental factors as providing the best opportunities for outperformance between high- and low-ESG investment-grade corporate bonds.
As evidence of the opportunity for investors and fund issuers alike, research from Sage Advisors said only 0.5% of fixed-income assets in the U.S. Morningstar fund and ETF universe are aligned with ESG, compared to 1.7% of equity fund assets.
While the Bloomberg Barclays MSCI fixed-income indexes solve for the availability of eligible securities by overlaying specifically non-fixed-income ESG factors, the green bond fund market likely will be constrained by the issuer market, making a product such as VanEck's Green Bond fund more of a complementary holding.
Moving such holdings into a core fixed-income exposure, an aspirational goal but attainable for equities indexing in some circles at least, is years if not decades away. While ESG investing seems to be in a constant state of ascendancy, ETF issuers are willing to stake some new products on the hope that trend fully arrives sooner than expected.n