Here’s an Aggregated Bond ETF Option That Emphasizes ESG

The current trend towards more environmental, social and governance (ESG) investing suggests that it’s only here to stay. In the case of ETFs, more and more investors are seeking funds out that match up with their ESG initiatives.

It’s not just equities where this growth is taking place. In 2019, for example, there were 479 green bonds issued worldwide and that is only expected to grow in 2020.

For ETF investors looking for fixed income exposure with an ESG component attached, they can look to the iShares ESG U.S. Aggregate Bond ETF (NYSEArca: EAGG). EAGG seeks to track the investment results of the Bloomberg Barclays MSCI US Aggregate ESG Focus Index, which has been developed by Bloomberg Barclays Capital Inc. with environmental, social and governance (“ESG”) rating inputs from MSCI ESG Research LLC pursuant to an agreement between MSCI ESG Research and Bloomberg Index Services Limited or an affiliate.

“IShares ESG U.S. Aggregate Bond ETF is a solid core-bond holding for ESG-minded investors,” wrote Benjamin Joseph in Morningstar. “This low-cost index fund looks a lot like the Bloomberg Barclays U.S. Aggregate Bond Index. That’s by design. It tracks the Bloomberg Barclays MSCI US Aggregate ESG Focus Index, which matches its sector weightings to that benchmark and only applies an ESG adjustment to the corporate-bond sector, and here the adjustment is modest.”

“The fund removes corporate-bond issuers with the lowest ESG scores from the eligible universe and uses an optimizer to tilt toward the highest-scoring issuers remaining,” Joseph wrote. “However, these adjustments must not take the fund’s expected tracking error relative to the Aggregate Index above 10 basis points per year, which limits the magnitude of this tilt, keeping it from just owning bonds from the highest-ranking issuers.”

Investors can almost think of EAGG as the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG), but with an ESG tilt. AGG seeks to track the investment results of the Bloomberg Barclays U.S. Aggregate Bond Index, which measures the performance of the total U.S. investment-grade bond market.

“The resulting portfolio has credit and interest-rate risk that are very similar to the Aggregate Index,” added Joseph. “As a result, its performance should mirror that bogy, which it has done since it launched in October 2018. However, the fund’s ESG adjustment will likely increase turnover and may cause it to overweight smaller corporate-bond issues, which can modestly increase transaction costs. The ESG scores that this fund uses are based on MSCI’s assessment of each issuer’s ESG practices relative to industry peers.”

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