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Fixed income is gaining ground in ESG with rapid growth in AUM of ETFs

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This is a sponsored article from Amundi ETF.

For years, fixed income trailed equities in environmental, social and governance (ESG) investing. But things have been changing fast. As demand for ESG bonds has soared, so has the choice of efficient passive ESG fixed income solutions.

Fixed income catching up fast in ESG

The first bond ESG index was launched in 2013, a full 23 years after its ESG equity index equivalent. Since then, compared to equities, progress to integrate ESG considerations into bond portfolios has been slow, partly due to engagement factors. Bondholders lack shareholders’ voting rights, fostering the myth that they have limited ability to exert influence on companies. Of course, while successful bond investing can be more a matter of avoiding losers than picking winners, the integration of ESG considerations into bond portfolios can help to reduce risk and improve returns. Furthermore, companies that regularly raise funds through bond issuance increasingly understand the benefits of listening to bondholders.

As more investors have recognised the virtuous circle, demand for ESG fixed income solutions has grown. AUM in European fixed income ESG ETFs soared from €20.1 billion at the end of 2019 to €55.2 billion1 by end-September 2022.

Better ESG accountability with more data

Incorporating ESG analysis in fixed income investing brings several potential benefits. ESG scrutiny of bond issuers may reveal exposure to long-term investment risks, such as climate change, that may take years to materialise. Additionally, several studies2 have suggested that companies with strong ESG credentials are less likely to default, and more likely to be profitable over the long term.

ESG factors are playing a more important role in credit ratings, and bond investors are increasingly engaging directly with companies, holding them accountable on ESG issues. Bondholders recognise that lacking the voting rights of shareholders in no way lessens their right as stakeholders to engage with issuers (who are often also stock issuers). Keen on attracting ESG investors and gaining inclusion to major indices, bond issuers have become more willing to share information.

The availability of data from ESG information providers in previously neglected areas, such as government bonds, has also improved. For several reasons — including the lack of consistency in measuring material ESG factors — government debt lags far behind corporate credit in ESG integration terms, although greater investor scrutiny of ESG issues is helping to narrow the gap.

Fixed income ESG ETFs shine during pandemic

COVID-19 triggered market turmoil and tested portfolio resilience, with many investors re-evaluating their fixed income allocations. ETFs thrived amid the volatility, proving themselves nimble and resilient. Bond ETFs traded in large volumes, even in segments with dwindling liquidity. Monetary authorities, including the Federal Reserve and the Bank for International Settlements, recognised the versatility of ETFs, even highlighting their role in price discovery, particularly in fixed income. COVID-19 also sharpened investor focus on ESG, illustrated by in-flows of €18.1 billion in European fixed income ESG ETFs over the last 12 months1.

The attraction of fixed income ESG ETFs:

  • Cost-efficiency – helps make sustainable fixed income solutions accessible to all investors.
  • Transparency – investors can see what the portfolio holds by looking at the constituents of the underlying index.
  • Diversification – risk can be spread across hundreds, even thousands, of stocks.
  • Highly liquid – even in times of market stress.
  • High correlation with their parent (non-ESG) universe, and minimal tracking error.

Robust growth and innovation ahead

In our view, rising investor appetite for fixed income ESG ETFs will keep driving product innovation and choice for investors. We see great opportunities for fixed income to grow its share of sustainable assets globally.

More investors are using ETFs to implement ESG fixed income in their portfolios and we expect innovation and AUM in these dynamic instruments to surge. This should ultimately lead to greater choice for investors, enhancing their ability to incorporate sustainability in portfolios reflecting their investment beliefs and objectives.

Find out more here.

1 Source: Amundi ETF / Bloomberg, end September 2022
2 For example, ISS ESG in 2020; McKinsey in 2019.

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This is a sponsored article from Amundi ETF.

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