The concept of environmental, social and governance (ESG) investments may be struggling to break into the mainstream, but it may be turning a corner as demand for ESG fixed income products exceeded supply, according to new research by Cerulli Associates.
The report revealed that inflows into ESG fixed-income products surpassed $11.4 billion the last two years, but a shortage of benchmark indexes that measure ESG-focused criteria makes it difficult for its inclusion in the asset class. However, an influx of new ESG fixed-income products into the market over the next few years could help appease increased demand.
“Cerulli research shows an increase in demand for ESG in all segments of the fixed-income market,” said André Schnurrenberger, managing director for Europe at Cerulli, in a press release. “We expect to see the launch of a variety of new ESG products over the coming years, including in areas less suited to ESG, such as high yield.”
ESG Fixed-Income Innovations
The focus on environmental, social and governance (ESG) investing has made headway in the form of equities, but investors are also looking at opportunities within the fixed-income space where funds can make innovations to meet this demand. Areas of fixed income that are currently experiencing innovations to fulfill investors’ needs for social responsibility include green bonds and portfolio ratings that include ESG.
Types of fixed-income ESG investments can include green bonds, which are debt issues used to fund projects with a focus on positively impacting the environment. The proceeds from green bonds are allocated towards green initiatives and projects–backed by the debt issuer’s balance sheet. The chart below specifies the types of green bonds available for investors.
In addition to green bonds, investment firms like Pimco and Fidelity Investments are in the forefront of building their sustainable fixed-income funds through the selection of debt issues of companies with excellent ESG ratings. In addition to selecting fixed income investments based on credit quality, investors can now filter debt issues via their contributions towards social responsibility.
The challenge to bring ESG investing into wider investor adoption faces various obstacles, but more education and marketing towards these products, equities or fixed-income, can help increase awareness of these products.
“The inclusion of ESG factors in fixed income is becoming more widespread, with ESG data and ratings now available for most investment-grade credit issuers, as well as a large proportion of high-yield issuers,” said Ilonka Oudenampsen, senior analyst in European institutional research at Cerulli. “In addition, there have been several important innovations in the fixed-income space, including the rise of green bonds and the emergence of social bonds and bonds linked to the [United Nations]’ sustainable development goals.”
Flight to Short Duration
In the general bond market space, the trend continues to be investors fleeing to short-term debt found in investment vehicles, such as short duration exchange-traded funds (ETFs). The flight to debt with shorter maturities reflects the move from “risk-on” to “risk-off” as U.S. equities, particularly technology sector giants like FAANG stocks (Facebook, Amazon, Apple, Neflix, Google-Alphabet), have been racked by volatility the last couple of months.
“Investors seem to be struggling with whether international equities offer an upside alternative to a US environment weighed by future rate hikes, tenuous trade relations and slowing corporate growth,” said Brian Gilman of Virtu Financial. “Domestically, the shift to risk-off is most apparent and it’s in the headlines and on the TV every day. The darling FAANG stocks are in a bear market and the high beta, growth names associated with them are no longer in favor.”
Investors can look to ETFs, such as the SPDR Portfolio Short Term Corp Bd ETF (NYSEArca: SPSB), which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index. Another option is the iShares 1-3 Year Credit Bond ETF (NASDAQ: CSJ), which tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years.
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