Morgan Stanley launched the actively managed Calvert Ultra-Short Investment Grade ETF (CVSB) along with five other environmental, social, and governance (ESG) funds under the Calvert brand earlier this year. Brian Ellis, an executive director with Morgan Stanley, is one of the portfolio managers for the ESG ultrashort bond fund. VettaFi spoke with him about the fund’s management and how it incorporates ESG principles.
VettaFi: How does an ESG strategy manifest in a fund like CVSB?
Brian Ellis: There are so many different takes on what you call ESG. I think it’s important to talk about our process for how we bring it into the portfolio. First and foremost, we’re very focused on investment performance. Our investment process relies heavily on our strengths in credit research, portfolio management, and trading. As part of that investment process, we have integrated proprietary research into the process. The end result is we’re investing in a portfolio of high-quality bond issuers that help us meet our investment performance objectives.
We’re also managing risks. Within that [are companies] that are demonstrating what we’ve considered effective management of key environmental, social, and governance risks. We’ve always valued a strong, dedicated research team with Calvert, and they exclusively focus on this. If you treat that research, with the same integrity that you do in a regular fundamental investment process, like credit research, you get better results. When it’s done correctly, with a focus on those factors that are material to that particular issuer, that has the potential to reduce risk in the portfolio. [And that is] actually very important for a short-term, fixed income strategy given that those strategies should be a little more focused on managing risks than you would see in some other parts of the fixed income market.
A Bottom-Up Approach
We don’t exclude sectors on a top-down basis. We evaluate every issuer from a bottom-up perspective relative to peers, similar to a credit research approach. We’re trying to assess how well they’re managing those financially material ESG risks and opportunities. We do not invest in those that are not, and we find the ones that will meet our investment objectives and that are effectively managing those risks. Some industries are inherently exposed to higher ESG risks, such as [energy transition risks], and those very high-risk industries won’t be as represented in this portfolio. [Instead,] you would see us investing more in some of the leaders in that space that have demonstrated effective management of risks.
VettaFi: What does the investment process for CVSB generally look like?
Ellis: Our investment objective in CVSB is to outperform the Bloomberg 9-12 Months Short Treasury Index. We’re typically thinking about an investor with a six to 12-month time horizon in what we’re adding to the portfolio. A multi-sector approach is really the best way to earn a higher yield over time, which is probably the most important driver of our returns and also our strategy. Your yield is very indicative of what your total returns will be. But it also can help mitigate downside risks.
Multisector gives you a really wide opportunity set to choose opportunities from and you can vary that through time depending on the macro environment and where you see better valuations. That’s a better approach than concentrating exclusively on a particular sector always. You can probably earn more yield over time, and you can also manage risk better.
A Diversified Investment-Grade Portfolio
Our focus in CVSB is exclusively on investment-grade securities. Within that, we diversify the portfolio across a variety of sectors, including short-term corporate bonds, government-backed securities, commercial paper, and securitized assets. Diversification is actually very important when you’re trying to manage risk. Your bottom-up security selection is very important. We work closely with analysts and traders across many investment teams in the firm to really bring those best ideas into the portfolio. And we do all that while managing the overall portfolio duration to a year or less. We can own both fixed rate and floating rate securities to help meet that objective.
VettaFi: Please tell me a little more about how CVSB’s portfolio breaks down into different fixed income sectors.
Ellis: We’re very U.S.-dollar-focused. We can have up to 25% in foreign issuers, but they’re all U.S. dollars in terms of currency. Corporate bonds – I would include commercial paper in that category as well – tends to be the core part of the portfolio, the biggest part. We do own Treasuries. They’re very liquid assets and a big part of our benchmark.
We use securitized assets to a lesser extent than corporates, but they are well-represented in the overall portfolio. With ABS, CMBS, and MBS, you can actually pick up significant yield in a portfolio relative to some parts of the corporate market to Treasuries, so we like building those in. They’re diversifiers and also yield enhancers.
Two Driving Forces
VettaFi: Why would an investor be interested in an ESG ultrashort bond ETF?
Ellis: I was thinking about it in two ways because we’ve seen growth across the entire category. You’re certainly seeing more entrants into the space in ultrashort. There are two driving forces right now. First, the magnitude of monetary policy tightening over the past year has resulted in yields that are just really very attractive right now. And from a current yield perspective, cash looks very attractive relative to other asset classes.
I think this is why we’ve seen investors maintaining or even growing their already large cash and money market fund allocations. Shorter duration strategies give you the potential to pick up more yield relative to cash and money market mutual funds, but still focus on managing risk. As rates remain elevated, investors have been looking for ways to enhance returns. We think that will actually continue as rates stay high at the front end of the curve, and ultrashort strategies can be really useful to enhance some of those returns relative to cash. That’s probably the most important macro driver right now.
Second, the demand for sustainable investment strategies continues to be very strong. We’ve continued to see very strong demand across the Calvert franchise, despite some of the recent market volatility in the past year. We’ve been able to thoughtfully integrate that research into our investment process and also maintained our focus on investment performance. That is so critical, and we think this is especially true in the fixed income market, where there are not a lot of managers and funds who have done this successfully.
There will be more demand over time, and there will be more interest in the space. I think the combination of those two drivers really makes us more optimistic about CVSB’s potential for sure.
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