Investors looking for areas of the fixed income landscape where environmental, social and governance (ESG) principles has legitimate expansion potential need not look too far beyond investment-grade corporate debt.
The iShares ESG USD Corporate Bond ETF SUSC proves as much. SUSC, which debuted about two and half years ago, is higher by about 14% this year, putting it slightly ahead of the largest traditional investment-grade corporate bond ETF.
While the idea of applying ESG principles to bonds via the ETF wrapper isn't old, SUSC offers many of the same benefits as its older legacy counterparts. For example, the iShares fund features a deep basket of securities (nearly 1,800 holdings), a palatable fee of just 0.18% per year and a compelling 30-day SEC yield of 2.75%.
Why It's Important
SUSC has $67.11 million in assets under management, a tally that could easily grow as more investors flock to ESG bond funds.
“The need for sustainable fixed income solutions is growing: Bonds are in high demand – against a backdrop of aging populations in search of income and geopolitical volatility that has sparked greater demand for 'safe' assets,” BlackRock said in a recent note. “We believe fixed income investors can draw on many of the insights that equity-focused research has produced on ESG.”
There is some evidence that better ESG profiles can lead to higher credit ratings and imply that issuers are quality companies. For example, about 46% of SUSC's holdings are rated AAA, AA or A.
“Companies or issuers with strong ESG performance are likely to be better at managing operational and reputational risks,” BlackRock said.
About 47% of SUSC's issues hail from the financial services, consumer cyclical and technology sectors – groups that often score well on various ESG metrics.
The fund's 20% weight to corporates issued by banks could prove meaningful over time.
“The materiality of each of the ESG pillars varies across industries. Take financials. The 'E' pillar appears to have more sway on market pricing than commonly thought,” said BlackRock. “We found a meaningful link between returns on banks’ corporate debt and 'E' factors such as low carbon transition. Why is this the case even though bank operations have little direct exposure to environmental factors? Bank loans to fossil fuel producers may be at risk of future losses in a scenario in which carbon taxes are introduced, for example. We believe such analysis on an industry level can help inform investment decisions.”
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