According to our recent survey of more than 350 global institutional investors,1 61% are prioritizing the integration of ESG factors in their fixed income portfolios over the next three years.2 This validates the strong trend of asset growth in the evolving fixed income ESG universe now comprised of nearly 1,000 funds globally with total assets of $450 billion under management, with $41 billion in North America and $404 billion in Europe.3
Although most of these assets have been invested in active mutual funds, there has been a meaningful uptick in both the number of ESG fixed income exchange traded funds (ETFs) and their adoption by investors. In 2020, ESG fixed income ETFs had inflows of $12.9 billion, more than three times the previous record year.4 Inflows the first eight months of 2021 have already surpassed that figure.5 More than half (58%) of all respondents in our survey noted that they will most likely use ETFs as their preferred investment vehicle for increasing allocations to fixed income ESG strategies, with investors in North America (68%) having a stronger preference for ESG-related ETFs than those in Europe (50%).6
Global ESG Fixed Income Fund Universe
How can investors incorporate ESG?
There is no one standard approach to incorporating ESG into a fixed income portfolio. Methodologies vary from strictly excluding investments based on ethical or value considerations to ESG integration devoid of any negative screening. These diverse approaches can be broadly grouped into five categories:7
Common Methods of ESG Incorporation
These methods are not mutually exclusive; where feasible, they can be combined to achieve an investor’s overall investment objectives.
However, it is also important to note that fixed income is a much more diverse asset class than equities — spanning corporate bonds, sovereign and government-related bonds and securitized and private debt. The opportunity set to incorporate these methods has increased significantly for corporate bond investors as companies have responded to the importance of acknowledging ESG considerations. From providing more useful and relevant data points to the creation of bonds with specific sustainable projects or goals, a growing amount of corporate debt now meets ESG mandates. While this makes it possible for investors to be consistent in how they reflect their ESG values and objectives across both their equity and corporate bond exposures, it remains more challenging to assess sustainability risks of other fixed income security types, such as sovereign bonds and securitized products.
How are issuers participating in ESG?
Fixed income issuers have become an integral part of ESG adoption and asset growth. For an issuer to be properly rated from an ESG perspective, relevant and robust data must be available. Governments, municipalities and companies are more aware of ESG-related elements and, in some cases, have established new roles or divisions to work with the investment community. The resulting greater data availability has improved the accuracy of ESG ratings for bond issuers, allowing investors to more confidently focus on those with higher ESG ratings.
There are also specific securities that have defined responsible investment guidelines and strict requirements about how the proceeds of those investments are used. Although small when compared to the broader bond market, this universe of bonds is growing and currently stands at more than $300 billion of new corporate issuance through the first three quarters of 2021.8 Targeted at generating climate, social or other environmental benefits, these bonds typically fall into one of four categories:9
Choosing these bond categories allows investors to influence and have better views into the use of proceeds at the issuer level than they would have with general issues.
What are investors prioritizing?
In terms of how institutional investors are incorporating ESG issues into their fixed income portfolios, our research identifies best-in-class as the most popular ESG fixed income approach, with 49% of respondents using the method. Our survey also revealed regional differences in the incorporation of ESG preferences, with 42% of North American respondents employing best-in-class compared to 50% of European respondents. This trend was reversed for Impact investing, which was employed by 50% of North America respondents and just 34% of those in Europe.12
Once investors choose an ESG incorporation method, or a combination of methods, they must evaluate the investment opportunities and weigh the style of investing (active or index). Survey findings indicate investors favor certain styles based on what the specific ESG strategy entails. For a broad ESG strategy, an index approach is favored. For targeted social or targeted climate/environmental strategies, an active approach is favored.
Future Fixed Income ESG Strategy Allocations
The State Street Global Advisors Approach
Index investing can be an ideal way to gain exposure to broad ESG factors in a fixed income portfolio. But to do that, data must be aggregated to measure the performance of a company’s business operations and governance as it relates to financially material ESG challenges facing the company’s industry. This is why State Street Global Advisors developed R-Factor, a proprietary ESG scoring system that draws on data from multiple providers and leverages commonly accepted, transparent materiality frameworks to generate a unique ESG score for listed companies.
Street Global Advisors uses R-Factor to provide a best-in-class, index strategy focused on the investment-grade corporate bond sector. Launched in 2020, the SPDR® Bloomberg SASB® Corporate Bond ESG Select ETF (RBND) can be used as a core ESG building block to gain exposure to firms exhibiting certain financially material ESG characteristics. RBND is just one example of the different types of solutions from State Street Global Advisors that are available to help investors incorporate ESG into their portfolios.
1 In partnership with Longitude Research, a Financial Times company. The research also included in-depth telephone interviews with two institutional portfolio managers (one in North America and one in Europe).
2 Fixed Income: Preparing for the Big Shift, State Street Global Advisors, June 2021. Research done in partnership with Longitude Research, a Financial Times company. The research also included in-depth telephone interviews with two institutional portfolio managers (one in North America and one in Europe).
3 Morningstar Direct, as of August 31, 2021. Refers specifically to the Global ESG Fixed Income Universe of Funds.
4 Morningstar Direct, as of August 31, 2021. Refers specifically to the Global ESG Fixed Income Universe of Funds.
5 Morningstar Direct, as of August 31, 2021. Refers specifically to the Global ESG Fixed Income Universe of Funds.
6 Fixed Income: Preparing for the Big Shift, State Street Global Advisors, June 2021.
7 ESG Investing - An Introduction for Investors, State Street Global Advisors, April 2021.
8 Corporate ESG bond issuance: Q3 21 update, Barclays, October 2021.
9 ESG in Fixed Income, State Street Global Advisors, 2020.
10 Fixed Income: Preparing for the Big Shift, State Street Global Advisors, June 2021.
11 ESG Investing: Combining Performance and Impact in Fixed Income, State Street Global Advisors, June 2020.
12 ESG Investing: Combining Performance and Impact in Fixed Income, State Street Global Advisors, June 2020.
Important Risk Discussion
Investing involves risk including the risk of loss of principal.
The views expressed in this material are the views of Mark Pawlowski, Thomas Coleman, Rupert Cadbury and Benjamin O’Dwyer through the period ended September 30, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Responsible-Factor (R Factor) scoring is designed by State Street to reflect certain ESG characteristics and does not represent investment performance. Results generated out of the scoring model is based on sustainability and corporate governance dimensions of a scored entity.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.
Passively managed funds hold a range of securities that, in the aggregate, approximates the full index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.
BLOOMBERG®, a trademark and service mark of Bloomberg Finance L.P. and its affiliates, and BARCLAYS®, a trademark and service mark of Barclays Bank Plc, have each been licensed for use in connection with the listing and trading of the SPDR Bloomberg Barclays ETFs.