Take a Look at ESGB Because Bonds Still Merit Attention

In the fixed income arena, investors with an eye toward environmental, social, and governance (ESG) principles may want to evaluate swapping out of old guard aggregate bond strategies in favor of fresher approaches such as the IQ MacKay ESG Core Plus Bond ETF (ESGB B-).

The fund is actively managed, which is relevant because, particularly in the bond world, active managers can more readily identify credible ESG opportunities. Of course, ESGB’s status as an actively managed ETF may also offer investors benefits in terms of mitigating duration risk, which is a primary consideration because the Federal Reserve likely has a few more rate hikes ahead of it.

“The Federal Reserve is taking aggressive steps to tamp down inflation and has said that it plans to continue raising rates at least through September before potentially pausing to see how well rate increases are working to control inflation,” wrote Morningstar analyst Amy Arnott.

Still, there’s a case for ESGB, and it extends beyond near-term interest rate headwinds. Bonds are essential ingredients in damping portfolio risk — something to consider, particularly if a recession sets in.

“Bonds are inherently less risky because their owners get more of their cash flows up front and have more certainty about receiving a given value at maturity. Their value primarily hinges on two things: the issuer’s underlying credit quality and changes in market interest rates. As residual assets, stocks have much more upside potential, but they are guaranteed to be riskier,” noted Arnott.

Importantly, credit risk is currently minimal with ESGB because its portfolio is heavy on various forms of U.S. government debt. As such, about two-thirds of its holdings carry ratings of AAA, AA, or A.

However, as an active fund, it’s possible that ESGB can identify credit opportunities when ESG mandates allow. Overall, ESGB offers investors a prime avenue for combining the benefits of ESG with bonds while adding a way to diversify portfolios.

“Bonds can also provide diversification benefits thanks to their generally low correlations with stocks. Even during periods of rising interest rates, bonds usually have a lower correlation with stocks than most other major asset classes, which enhances their ability to reduce risk at the portfolio level,” concluded Arnott.

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