The development of “sustainable” government bond funds may be hitting a road bump as fund managers fear being overly critical of western government policies, notably those of the United States.
Corporate bonds can be ranked by a similar environmental, social, and governance, or ESG, scoring systems that are used for equities, but “there are still question marks over how to best evaluate government debt, where there is a fine line between making an objective ESG assessment and straying into political territory”, Kenneth Lamont, research analyst for passive strategies at Morningstar, told the Financial Times.
“Taking a stand against the policies of an elected government, even if rationalized from an ESG perspective, is something that individual investors may find easy to do. However, large asset managers or ESG-rating companies risk being accused of unduly interfering with a political process,” Lamont added.
Passive ESG-themed fund strategies have attracted hefty inflows over the past 18 months, with assets doubling to $250 billion, according to Morningstar data.
While the ESG theme has boomed on the equity fund side, Morningstar warned that the rollout of passive ESG bond funds remained “embryonic” compared to equity ESG funds, mostly due to “challenges of assigning ESG ratings to government debt”.
The debate over ESG debt issuers is most pronounced in the U.S. where some argued has failed to meet the necessary ESG standards. However, the U.S. is still by far the largest issuer of debt, accounting for 36% of the FTSE World Government Bond Index.
“At what point do you exclude the US?” Lamont asked. “It is the biggest arms manufacturer in the world, you have social inequality. It is one of the biggest polluters and withdrew from the Paris Climate Agreement, and yet excluding the US from your fixed income exposure is problematic.”
The United States’ government bond market is just too big to ignore. Some fund groups had “admitted that if they were to strictly follow their ESG guidelines the US would be excluded”, Lamont said, but for investment reasons, they cannot ignore the “largest and safest” government bond market in the world.