Matthieu Guignard is global head of product development and capital markets at Amundi ETF, Indexing & Smart Beta
FIXED INCOME: MAKING GROUND IN ESG
Fixed income has long lagged equities in the environmental, social and governance (ESG) investing space, but rising demand for ESG debt is leading to the development of a rapidly expanding range of fixed income solutions.
Compared to equities, progress to integrate ESG considerations into fixed income portfolios has been slow. The first equity ESG index launched more than three decades ago, in 1990, but it was not until 2013 that the first ESG fixed income index was established. One reason for this lag relates to historically perceived issues with engagement. Bondholders do not have voting rights like shareholders lead- ing to a myth that they had a limited ability to engage and exert influence on companies.
However, with responsible investing ever more popular, there is a rapidly increasing investor appetite for, and availability of, ESG fixed income solutions, and in particular, ETFs.
The benefits of incorporating ESG analysis into fixed income investing are clear. ESG scrutiny on a corporate issuer may, for instance, reveal exposure to long-term investment risks, such as climate change,
that could take years to materialise. Indeed, it is increasingly recognised that companies with strong ESG credentials are less likely to default and more likely to be profitable over the long term.
ESG factors are consequently occupying a more important role in credit ratings and we are seeing greater ESG integration and issuer engagement.
Bond investors are becoming more willing to directly communicate with companies and hold them to account on ESG issues. Bond issuers, in turn, are now far more forthcoming in supplying information and there is more data available from ESG data providers, even on previously neglected areas such as government debt. The already growing demand for ESG fixed income ETFs surged in the wake of the Covid-19 pandemic, which sharpened investors’ focus on sustainability risks and highlighted ETF resilience.
In the ensuing market turmoil following the pandemic outbreak ETFs thrived, trading without interruption and offering investors instant market access with transparent, executable prices. Regulatory bodies, such as the Bank of England, highlighted the role of ETFs as a means of price discovery, especially in the fixed income space where ETFs provided an indication of the bonds’ fair value.
Flows to ESG fixed income ETFs have subsequently soared. Those listed in Europe attracted €20.5bn (£17.4bn) from January 2020 to June 20211, compared with €4.2bn (£3.5bn) in 2018 and 2019 combined2. Increased demand has also driven innovation, European fixed income ETFs incorporating ESG criteria rose from 4% in 2018 to 18% by end of June 20213.
ESG progress in the fixed income market has a long way to go. There is still a lack of consistency in the level of ESG infor- mation provided by bond issuers, par- ticularly for sovereign debt, making ESG due diligence challenging. Moreover, fixed income assets still only account for a small proportion of sustainable assets globally.
However, with sustainable investing increasingly seen as a necessity not a lux- ury in managing long-term investment risks, such as climate change, things are fast improving.
And with benefits including low costs, liquidity, transparency and diversification, ETFs are increasingly the vehicle of choice to implement ESG in fixed income.
