Why ESG Bonds Have Not Gained as Much Traction

While socially responsible investments are attracting greater attention, the universe of environmental, social, and governance bonds remain an underrepresented asset class in investment portfolios.

According to Morningstar data, ESG bond assets have tripled in the past three years, reaching a total of $350 billion, Institutional Investor reports. In 2020, ESG bond assets expanded by 66%, compared to the overall fixed income market’s growth of 12%.

However, while fixed income makes up 27% of the overall fund market, ESG bond funds only account for less than one-fifth of total ESG fund assets.

Morningstar analysts attributed this shortfall to several factors, pointing out that “it’s early days” for ESG bonds. Fixed income investors have only started to seriously look into ESG integration for about 10 years.

“The inherent complexity of bond markets, with their wide spectrum of different debt instruments, issuer types, and maturities, has held back ESG integration in fixed income, and thus also sustainable fixed-income products,” a report said. “This has been compounded by concerns over data availability, quality, and comparability, especially for sovereign debt.”

Analysts argued that the overall lower levels of active ownership in fixed income are also a hurdle for ESG bonds.

“Despite all the challenges, however, ESG integration in fixed income has become more widespread in recent years,” Morningstar said in the report. “Investors have come to realize that ESG considerations are just as important in fixed income as they are in equity when it comes to identifying downside risk. Also, evidence is growing that the integration of ESG can create alpha in corporate bond markets and can even outperform non-sustainable investments.”

According to Morningstar, “assets with an explicit green bond objective” had $24.9 billion in assets by the end of the first quarter of 2021. However, investors still view the debt class as a niche play in the global bond market, and the category continues to struggles to compete with traditional fixed income assets.

“Green bond funds still only represent 0.2 percent of assets in fixed-income investment funds worldwide,” the report added. “This is a 120 percent increase from $11.3 billion in 2019 and almost a fourfold increase from $6.3 billion at the close of 2018.”

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