Why ESG Is Meaningful With Fixed Income ETFs

Environmental, social, and governance (ESG) ratings are an increasingly prominent part of the investment lexicon and that theme extends to multiple asset classes, including bonds.

As such, advisors and investors are clamoring for more fixed income exchange traded funds that integrate ESG principles. Some of those solutions are already on the market, including the IQ MacKay ESG Core Plus Bond ETF (ESGB). The actively managed ESGB attempts to beat the widely followed Bloomberg US Aggregate Bond Index.

ESGB is heavily allocated to the U.S. government, which is appealing from the standpoint of the fund potentially offering an upside when Treasury yields decline. Additionally, the ESG bond ETF could be useful for income investors that are looking to eschew risk. The $253.5 million ESGB is also useful because data confirm the negative consequences of adverse ESG circumstances on issuers’ credit ratings.

“Using two decades of data, we compared corporate downgrade notches from one year before an episode of social unrest (based on episodes included in the IMF’s Reported Social Unrest Index) to two years afterward. There was a distinct rating deterioration around the time of the unrest and a worsened rating trend within two years afterward. The pattern was more pronounced in emerging markets, likely because advanced economies generally have greater fiscal and economic space to respond to and mitigate social risks,” noted Moody’s Investors Service.

Speaking to the potential advantages offered by ESGB as an actively managed relative to index-based competitors is the social element. As in the impact social unrest can have on some issuers, both sovereign and corporate. That’s a point to consider at a time when more market participants are demanding added emphasis on social and governance issues.

“The occurrence of social protests by itself does not lead to corporate credit deterioration. It is the extent to which these events refract risk through three channels – financial market volatility, economic performance, and government fiscal and institutional strength – that determines whether they affect corporate credit profiles,” adds Moody’s.

Several points work in favor of ESGB, including the ETF’s focus on domestic debt, which limits exposure to social unrest, and stellar credit quality, as highlighted by the point that more than two-thirds of the ETF’s holdings sports ratings of AAA, AA, or A. ESGB currently sports an unsubsidized 30-day SEC yield of 4.41%, which is compelling when accounting for that strong credit profile.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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