Five Ways to Fold ESG Into Your Fixed Income Portfolio

ESG investing is sweeping across the investment landscape and making a home in every corner of every market. With over 1,000 funds related to ESG available in the fixed income space alone, it’s important for advisors to be up to speed on their investment options within fixed income, which saw inflows of $12.9 billion in 2020, a threefold increase over the previous year, reports State Street Global Advisors in a white paper .

Source: Five Ways to Fold ESG Into Your Fixed Income Portfolio

So far in 2021, inflows into fixed income ESG ETFs in the first eight months have already passed last year’s numbers; with more investors wanting to align with the principles, understanding what types of ESG funds exist and how they target ESG is important. Broadly speaking, ESG funds can be broken down into five categories, all with different methods of incorporating ESG into their strategies.

Exclusionary is the oldest, most common, and generally the best-known style of approach. This model is called exclusionary or negative screening because it leaves out companies, countries, sectors, or anything else that is being screened against based on ESG metrics and factors. It’s a type of investing that is beneficial for investors who don’t want to allocate funding to companies that have practices that are against their values or else want to put their funds in alignment with a specific initiative. The drawback is that while it withholds funding to certain companies engaged in harmful practices as determined by the screening metric, those companies don’t get any engagement or incentive to change those practices.

Best-in-Class is an investment strategy that is sometimes referred to as a positive screen, as it invests in companies, sectors, and countries that have highly rated ESG practices and performance related to peers or the investment universe. With the influx of ESG data available now, this method is garnering increased attention from investors, particularly as research is reflecting the potential for outperformance of funds that rank higher on ESG versus lower-scoring ESG peers in the long run.

ESG Integration means including material ESG metrics into both the decision-making and analysis parts of investing. It is a systematic approach that is fairly explicit in its use of data, as opposed to an overlay strategy.

Thematic Investing is becoming increasingly popular for ETFs all around, but within the ESG space, it means that a fund aligns its assets along a specific theme related to ESG. Some variations of these include aligning with United Nations Sustainable Development Goals such a carbon emission reductions, healthcare, generalized climate change, and so on. Funds of this type are usually angling to hit a specific metric, but almost always align along Paris Climate Agreement goals of limiting global warming to 1.5 degrees Celsius.

Impact Investing generally looks at an issue or end outcome and then invests accordingly. Within ESG, these are most often specific environmental issues such as carbon reduction. Otherwise, the issues tend to be social in nature. The priority of the fund isn’t on the returns, but instead on the impact of the investment and asset towards the desired goal. Funds of this type include ones focused on conservation, education, affordable healthcare, or renewable energy, to name a few.

While many funds follow one approach, they are not necessarily mutually exclusive; often, a fund can carry more than one ESG investment strategy in order to help an investor achieve their goals, particularly within the fixed income space, which is more diversified than equities.

SSGA currently offers a fixed income ETF with an ESG lens, the SPDR Bloomberg SASB Corporate Bond ESG Select ETF (RBND), which invests in sustainability bonds. The fund tracks the Bloomberg SASB U.S. Corporate Ex-Controversies Select Index and provides a sampling strategy to generally carry the same risk and returns of the index. The index measures the performance of investment-grade corporate bonds issued by companies with certain ESG qualities that also have risk and return qualities of the parent index, the Bloomberg U.S. Corporate Index.

RBND can be used as a core building block for ESG investing and carries an expense ratio of 0.12%.

For more news, information, and strategy, visit the ESG Channel.

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