ESG Investing For Dummies (For Dummies (Business & Personal Finance)) by Brendan Bradley

Author:Brendan Bradley [Bradley, Brendan]
Language: eng
Format: azw3
ISBN: 9781119771111
Publisher: Wiley
Published: 2021-02-25T16:00:00+00:00

In equity markets, the first two approaches described here would lead to a material “tracking error,” or a divergence in performance in comparison to the portfolio’s benchmark index. However, this isn’t as true for bonds because macro risks, such as changes in interest rates, represent the majority of total risk in fixed income. Therefore, over- or underweight allocations in a fixed income portfolio have less impact from a total risk perspective than would be the case for equities. As a result, fixed income investors don’t need to sacrifice their yield, diversification, or return targets under such approaches to an ESG bond index benchmark. Therefore, ESG bond indexes have allowed managers to create building blocks that investors can now use to form the core of sustainable multi-asset portfolios. This potentially allows investors to create portfolios that offer an improvement on their main sustainability metrics, including ESG scores, while closely following the fundamental traits of standard bond indexes, such as duration and yield.

Passive ESG funds, which include ESG factors, have seen large inflows since 2019, with overall assets under management doubling. However, the uptake for passive ESG bond funds remains emergent in comparison to equities. Still, in a low-yielding environment with very tight credit spreads, where clients are concerned about the threats of recession and geopolitical risk events, sustainability is quickly becoming a key dimension in the investment model. Therefore, many new bond indexes are being established that incorporate approaches like excluding given issuers from benchmark bond indexes and then re-weighting constituents to tilt the index toward ESG leaders with higher ESG ratings. Alternatively, investors are participating in indexes where a bigger exclusion policy is employed alongside a greater weighting toward the ESG leaders within each sector. This allows investors to have multiple ways in which to express their fixed income ESG views through more passive, index-driven exposures, an approach that is cheaper to deploy than an active management strategy.

Furthermore, ESG bond indexes also underlie exchange-traded funds (ETFs), which act as building blocks for beta (the responsiveness of a bond’s price relative to changes in the overall bond market), which can in turn reduce the fees associated with some exposure and focus other fees on active funds that can add alpha. In certain sectors or with certain products, investors are also using ETFs to access liquidity, where they can get in and out of exposure quickly. Moreover, trading bonds through ETFs enhances price discovery, where the price of the ETF helps provide input on pricing the fixed income portfolio overall, as an investor immediately has some information on the pricing of related underlying bonds.

Fixed income indexes are available for sustainable bonds as well as ESG-adjusted indexes for regular corporate or sovereign bond issuance. Research shows that in 2019 the Bloomberg Barclays MSCI Euro Green Bond Index returned 7.4 percent, which was higher than the 6 percent for the established Bloomberg Barclays MSCI Euro Aggregate Index of regular Euro-denominated corporate and sovereign bonds. Furthermore, Euro-denominated green bonds outperformed the Euro Aggregate Index for three of the last four years, by an average of 0.

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