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ESG investing – Don’t forget to consider bonds

Alfred Lee

ESG investing – Don’t forget to consider bonds

While ESG investing is not a new concept, it has certainly been gaining a lot of traction among the broader investment community over the last half decade. Environmental, Social and Governance, or “ESG”, factors are expected to become increasingly important, not only for retail investors but for larger, institutional investors as well. Socially Responsible Investing (SRI), which shares similar values as ESG, has been around for many decades, but was considered a niche requirement among a targeted subset of investors.

Much like SRI, ESG investing appeals to socially conscious investors. It considers a company’s environmental, social, and governance practices, but also gives weight to traditional financial measures, which makes it more attractive to a more mainstream audience, and delivers a greater impact through broader ownership.

In addition to this, the recent change in the White House administration will likely place an increased emphasis on sustainability going forward. Notably, the presidential platform not only focuses on an aggressive policy to reduce carbon emissions, but also underpins a push toward social equality and corporate governance. With the World Economic Forum driving a similar agenda, policies may be put in place that render it more punitive for traditional investors, focused solely on investment returns, to ignore these goals. 

For retail advisors, ESG may be important as existing clients increasingly prioritize this approach. As assets are transitioned to the next generation, this theme is statistically more likely to be considered as a vital investment criteria. In addition, institutional investors are increasingly taking an activist position in encouraging corporations to consider sustainability factors. Overall, as ESG considerations rise in significance, its impact will be felt even with investors that do not focus on these relevant factors.  

Asset Flows: Estimated net flows to Canadian sustainable investments (CAD, millions)

Asset Flows: Estimated net flows to Canadian sustainable investments (CAD, millions)

Source: Morningstar Direct, data as of March 31, 2020, excludes fund of funds.

ESG investing in bonds

  • Most investors place a bigger emphasis on the equity side of their portfolios when it comes to ESG considerations. However, sustainability screens can also be placed on fixed income for added impact. While equities facilitate an activist approach, fixed income solutions essentially allow socially conscious investors to allocate capital to companies that better align with their criteria.
  • For investors looking to build their own ESG bond portfolios, sourcing bonds alone can be challenging given that it is an inventory-based market. Applying an additional sustainability screen to a bond portfolio can be even more difficult to navigate. Instead, investors looking for such exposures can opt for ETFs that have pre-defined ESG rules.

ESG as a risk management framework

While most screens or tilts applied to investment processes are designed to generate alpha, ESG should be seen as a way to manage risk, while not sacrificing returns relative to a traditional benchmark. As previously mentioned, a greater focus on environmental factors can potentially create higher taxes or fees on companies that are less green. Social risk can also lead to reputational issues, as human capital is a company’s most valuable asset. Notably, a failure of corporate governance – by not having the appropriate rules, practices and processes in place – are what ultimately led to the demise of companies like Enron.

Fixed income ESG ETFs

BMO ESG US Corporate Bond Hedged to CAD Index ETF (Ticker: ESGB): Tracks the Bloomberg Barclays MSCI Canadian Corporate Sustainability SRI Index, which screens the parent benchmark based on MSCI ESG ratings. This is an efficient way for investors to access Canadian investment grade corporate bonds, while also prioritizing ESG considerations that align with their values.

BMO ESG US Corporate Bond Index ETF (Ticker: ESGF): Tracks the Bloomberg Barclay’s MSCI US Corporate Sustainability SRI Index, which screens the parent benchmark based on MSCI ESG ratings. Investors can efficiently access U.S. investment grade corporate bonds, with sustainability front of mind.

BMO ESG High Yield US Corporate Bond Index ETF (Ticker: ESGH - Unhedged/ESGH.F - Hedged): Tracks the Bloomberg Barclays MSCI U.S. High Yield Liquid Corporate Sustainability SRI Index which screens the parent benchmark based on MSCI ESG ratings. This offers clients a solution for exposure to U.S. non-investment grade corporate bonds, while also meeting their needs with   a greater focus on ESG criteria. High yield bonds are an area where ESG screening may be more relevant, given the smaller operations of companies within the universe. 


Alfred Lee

ESG investing – Don’t forget to consider bonds

While ESG investing is not a new concept, it has certainly been gaining a lot of traction among the broader investment community over the last half decade. Environmental, Social and Governance, or “ESG”, factors are expected to become increasingly important, not only for retail investors but for larger, institutional investors as well. Socially Responsible Investing (SRI), which shares similar values as ESG, has been around for many decades, but was considered a niche requirement among a targeted subset of investors.

Much like SRI, ESG investing appeals to socially conscious investors. It considers a company’s environmental, social, and governance practices, but also gives weight to traditional financial measures, which makes it more attractive to a more mainstream audience, and delivers a greater impact through broader ownership.

In addition to this, the recent change in the White House administration will likely place an increased emphasis on sustainability going forward. Notably, the presidential platform not only focuses on an aggressive policy to reduce carbon emissions, but also underpins a push toward social equality and corporate governance. With the World Economic Forum driving a similar agenda, policies may be put in place that render it more punitive for traditional investors, focused solely on investment returns, to ignore these goals. 

For retail advisors, ESG may be important as existing clients increasingly prioritize this approach. As assets are transitioned to the next generation, this theme is statistically more likely to be considered as a vital investment criteria. In addition, institutional investors are increasingly taking an activist position in encouraging corporations to consider sustainability factors. Overall, as ESG considerations rise in significance, its impact will be felt even with investors that do not focus on these relevant factors.  

Asset Flows: Estimated net flows to Canadian sustainable investments (CAD, millions)

Asset Flows: Estimated net flows to Canadian sustainable investments (CAD, millions)

Source: Morningstar Direct, data as of March 31, 2020, excludes fund of funds.

ESG investing in bonds

  • Most investors place a bigger emphasis on the equity side of their portfolios when it comes to ESG considerations. However, sustainability screens can also be placed on fixed income for added impact. While equities facilitate an activist approach, fixed income solutions essentially allow socially conscious investors to allocate capital to companies that better align with their criteria.
  • For investors looking to build their own ESG bond portfolios, sourcing bonds alone can be challenging given that it is an inventory-based market. Applying an additional sustainability screen to a bond portfolio can be even more difficult to navigate. Instead, investors looking for such exposures can opt for ETFs that have pre-defined ESG rules.

ESG as a risk management framework

While most screens or tilts applied to investment processes are designed to generate alpha, ESG should be seen as a way to manage risk, while not sacrificing returns relative to a traditional benchmark. As previously mentioned, a greater focus on environmental factors can potentially create higher taxes or fees on companies that are less green. Social risk can also lead to reputational issues, as human capital is a company’s most valuable asset. Notably, a failure of corporate governance – by not having the appropriate rules, practices and processes in place – are what ultimately led to the demise of companies like Enron.

Fixed income ESG ETFs

BMO ESG US Corporate Bond Hedged to CAD Index ETF (Ticker: ESGB): Tracks the Bloomberg Barclays MSCI Canadian Corporate Sustainability SRI Index, which screens the parent benchmark based on MSCI ESG ratings. This is an efficient way for investors to access Canadian investment grade corporate bonds, while also prioritizing ESG considerations that align with their values.

BMO ESG US Corporate Bond Index ETF (Ticker: ESGF): Tracks the Bloomberg Barclay’s MSCI US Corporate Sustainability SRI Index, which screens the parent benchmark based on MSCI ESG ratings. Investors can efficiently access U.S. investment grade corporate bonds, with sustainability front of mind.

BMO ESG High Yield US Corporate Bond Index ETF (Ticker: ESGH - Unhedged/ESGH.F - Hedged): Tracks the Bloomberg Barclays MSCI U.S. High Yield Liquid Corporate Sustainability SRI Index which screens the parent benchmark based on MSCI ESG ratings. This offers clients a solution for exposure to U.S. non-investment grade corporate bonds, while also meeting their needs with   a greater focus on ESG criteria. High yield bonds are an area where ESG screening may be more relevant, given the smaller operations of companies within the universe. 


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