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Key takeaways

  • With growing interest in sustainable investing, investors are going beyond equities to seek sustainability in fixed income.
  • ESG considerations can provide insight into fixed income solutions.
  • Investors can consider three possible approaches to get started with sustainable investing in fixed income: seek sustainability at the core, seek income, and seek impact with green bonds.

Fixed income investors, who for years have grappled with ultra-low interest rates, are becoming increasingly keen to allocate with an eye toward sustainability. There is increasing investor recognition that sustainability risks are investment risks. Sustainability-related insights can provide information about an issuer that may not be revealed through a traditional financial analysis.

For example, PG&E – a California-based utility – filed for bankruptcy and saw its debt downgraded from investment grade to junk due to claims related to wildfires.1 Prior to the credit downgrade, an ESG rating provider was rating the company an ESG laggard, in part due to the social and environmental risks of contributing to wildfires.2 In this case, the ESG analysis provided insights not yet reflected in a company’s traditional credit analysis.

Due to the growing recognition that environmental, social, and governance (ESG) considerations can be financially material, over 160 investors with more than $30 trillion in collective assets and 23 credit rating agencies have signed on to the “Statement on ESG in credit risk and ratings” developed by the United Nations’ Principle for Responsible Investments. The signatories have committed to incorporating ESG considerations into their credit ratings and analysis.3

To thread the needle with income and sustainability, more investors are looking to bond exchange traded funds (ETFs) to invest sustainably. The first sustainable fixed income ETF was launched in 2017, and since then U.S. sustainable fixed income ETF assets have grown at an annualized rate of almost 200%.4

Assets in sustainable fixed income ETFs have tripled in 2020 from 2019 levels

Chart: Assets in sustainable fixed income ETFs have tripled in 2020 from 2019 levels

Source: BlackRock as of 11/30/2020. AUM refers to assets under management in the U.S. sustainable fixed income ETF market from 12/31/2017 – 11/30/2020. Includes all U.S.-listed fixed income ETFs classified by BlackRock as sustainable. Compound Annual Growth Rate (CAGR): a measure of an investment’s annual growth rate over time, with the effect of compounding taken into account. CAGR growth figure refers to compound annual growth rate for period 12/31/2017 – 11/30/2020.

Three ways to access sustainable fixed income with iShares ETFs

Investors can consider three possible approaches to get started with sustainable investing in fixed income: seek sustainability at the core, seek sustainable income, and seek impact with green bonds.

Chart: Three ways to access sustainability in fixed income portfolios

#1: Seek sustainability at the core of your fixed income portfolio
Investors looking to introduce sustainability into their portfolios may consider replacing traditional fixed income exposures with sustainable fixed income exposures with similar risk-return and duration characteristics as the relevant broad market, while providing access to issuers with favorable ESG characteristics. Such “core” sustainable bond ETFs can be used both to diversify (or replace) core equity and bond exposures.

For example, the iShares ESG Aware U.S. Aggregate Bond ETF (EAGG) allows investors to access bonds from issuers with favorable ESG practices while seeking to maintain a similar risk and return potential as the Bloomberg Barclays US Aggregate Bond Index, a broad benchmark for U.S. multi-sector bonds.

#2: Seek sustainable income
With yields near all-time lows, investors looking for income generation from their fixed income portfolios may consider adding investment grade or high yield corporate bond exposure to their portfolios.

Sustainable investment-grade and high yield corporate bond strategies allow investors to continue pursuing their income-related goals, while also introducing sustainability in their portfolios.

For example, the iShares ESG Advanced High Yield Corporate Bond ETF (HYXF) allows investors to access high yield bonds from issuers with higher ESG ratings, while extensively screening out controversial industries.

#3: Seek sustainable impact with green bonds
Impact investment strategies seek to contribute to measurable positive environmental or social outcomes alongside financial returns. Investors looking to achieve sustainable impacts could consider introducing green bonds into their portfolios.

Green bonds are fixed income securities in which the proceeds are exclusively applied toward new and existing projects with environmental benefits. These projects could address areas such as climate adaption, sustainable water, or pollution prevention and control. Investing in green bonds allows investors to participate in the credit of the issuing entity, while also seeking to fund projects meant to deliver a measurable environmental impact through their fixed income portfolio.

Growing investor appetite for green bonds coupled with an increased focus on sustainability from debt issuers — supranational, sovereign, and corporate alike — has led to strong growth in the green bond market. Annual issuance of green bonds hit a record $255 billion in 2019 and has surpassed $200 billion this year. 5;6 Total assets in the green bond market have now surpassed $1 trillion.7

The iShares Global Green Bond ETF (BGRN) allows investors to access global investment grade green bonds.

Summing it up

iShares offers choice to fixed income investors looking to access sustainability. iShares Broad ESG bond ETFs are designed to help investors access sustainability at the core of the portfolio. Meanwhile, iShares Impact bond ETFs help investors seek to achieve measurable positive outcomes alongside sustainability goals through their fixed income investment. All types can help diversify equities and generate income — same as traditional bond ETF exposures but with more sustainability.

Karen Schenone, CFA
Head of U.S. iShares Fixed Income Strategy
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Sarah Kjellberg
Head of U.S. iShares Sustainable ETFs
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Contributing authors: Tanvi Pradhan, Claudia Silva