Compared with equity strategies, sustainable fixed-income funds provide fewer choices for investors.
Open-end funds that have been tagged by Morningstar as sustainable investments housed $1.8 trillion in assets globally as of mid-2019. Fixed-income funds accounted for approximately one fifth of this group as well as one fifth of its total assets (roughly $375 billion), while just over half the distinct strategies in that group were equity focused.
But we expect to see growth in the fixed-income universe as asset managers step up their sustainable-investing capabilities in light of increasing investor demand. The demand for sustainable investing includes any investment process that uses environmental, social, and governance criteria to evaluate or to assess the societal impact of investments.
Our latest report, “ A Primer on Sustainable Fixed-Income Funds,” explores the different ways asset managers in the United States and Europe are embracing ESG fixed-income investing. To understand their range of approaches, we talked to more than a dozen asset managers about how they are building out their ESG investing capabilities and sustainable fixed-income-fund lineups.
Here’s a look at what we found.
3 ESG fixed-income approaches that asset managers use
We found that the varied styles of sustainable fixed-income investing could be grouped into three main types: ESG Consideration, ESG Focus, and Impact Investing.
1. ESG Consideration: These strategies use ESG factors without gearing the entire investment process and outcome around them. This type of strategy uses ESG information in the investment decision-making process, but not generally at the portfolio-construction level. The prospectus generally implies that ESG factors don’t make or break an investment decision.
More asset managers are likely to start formalizing their ESG Consideration frameworks to meet growing investor demand but also as an acknowledgement that ESG risks are real and need to be addressed in any investment process.
However, this approach may be less satisfying for those who want ESG criteria to shape their bond portfolios in a more noticeable way.
2. ESG Focus: These strategies broadly integrate ESG criteria throughout the investment process. Typically, these funds’ managers aim to focus on the securities of firms that they believe are addressing sustainability challenges in ways that will make them better investments, and they aim to avoid companies that aren’t.
This is a more stringent approach to sustainability than ESG Consideration because all securities in the portfolio are subject to ESG analysis. Plus, similar work can extend to portfolio construction through in-house ESG views.
Investors who are passionate about sustainability may find more to like in this space than in ESG Consideration, but fund selection requires more legwork because many approaches fall under this umbrella.
3. Impact Investing: Impact Investing funds put environmental and/or social goals front and center, investing all or a portion of their assets in “companies, organizations, and funds with the intention of generating social and environmental impact alongside a financial return,” according to the Global Impacting Investing Network.
These funds invest directly in bonds that finance affordable housing, community development, green energy priorities, green infrastructure, or other projects meeting sustainability criteria. In practice, Impact Investing funds feature mandates that range from fairly narrow to fairly wide.
These strategies may be of particular interest to investors motivated by the general idea of using their money to help achieve societal impact alongside their own financial return.
ESG fixed-income strategies' goals can be hard to measure
Investors face many challenges when it comes to analyzing sustainable fixed-income funds. For instance, performance evaluations can be difficult because the track records for most sustainable fixed-income strategies, as well as the lifespans of ESG fixed-income benchmarks, are generally short.
And while we defined these approaches along three themes, we found that selecting an ESG Consideration, ESG Focus or Impact Investing strategy requires an extra layer of due diligence. That’s because there’s a lack of standardization around them, hard-to-measure environmental and societal goals, and difficulty in evaluating the degree to which ESG is truly integrated in a strategy.
The difficulty of comparing ESG fixed-income funds
Some asset managers are focused on meeting investors’ various interpretations of sustainable investing, and others, including Amundi, have offered ambitious plans to transform their lineups to meet their ESG goals. However, these plans could prove more difficult to execute in some areas of the market, such as high-yield bonds, where ESG information is not as readily available.
The success of firms will depend on their ability to efficiently apply ESG analysis to a much larger number of issuers. And with increasing demand for sustainable investments, asset managers may be tempted to take older, underperforming funds and repackage them as ESG strategies to give them a sales boost.
These issues, in addition to the lack of standardization in the nascent ESG fixed-income fund universe, call for more careful manager selection.