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Sep 2, 2020
News | Business | Finance | Exchange Traded Funds: ESG bond funds held back by fear of criticising US, research suggests
Fund managers’ unwillingness to criticise western governments,
particularly that of the US, is holding back the development of
“sustainable” government bond funds, research suggests.
While
corporate bonds can be scored using a similar ESG scoring system to that
used for equities, “there are still question marks over how to best
evaluate government debt, where there is a fine line between making an
objective ESG assessment and straying into political territory”, said
Kenneth Lamont, research analyst for passive strategies at Morningstar.
“Taking
a stand against the policies of an elected government, even if
rationalised from an ESG perspective, is something that individual
investors may find easy to do. However, large asset managers or
ESG-rating companies risk being accused of unduly interfering with a
political process,” he added.
Passive ESG funds, which incorporate
environmental, social and governance concerns, have seen huge inflows
in the past 18 months, with assets doubling $250bn, according to data
from Morningstar.
However, Morningstar said that the rollout of
passive ESG bond funds remained “embryonic” compared to that of
equities, with the sector held back by the “challenges of assigning ESG
ratings to government debt”.
The
debate about evaluating sovereign debt issuers may be most acute around
the US, which some could say fails to meet the necessary ESG standards,
yet is by far the largest issuer of debt, accounting for 36 per cent of
the FTSE World Government Bond Index.
“At what point do you
exclude the US?” asked Mr Lamont. “It is the biggest arms manufacturer
in the world, you have social inequality. It is one of the biggest
polluters and withdrew from the Paris Climate Agreement, and yet
excluding the US from your fixed income exposure is problematic.”
He
said some fund groups had “admitted that if they were to strictly
follow their ESG guidelines the US would be excluded”, but for
investment reasons decided that they cannot ignore the “largest and
safest” government bond market in the world.
Mr Lamont said this was less a case of “cowardice” on the part of fund providers, but rather one of “pragmatism”.
“It’s
quite a tricky issue how we rate government debt on its ESG
credentials,” he added. “We haven’t reached anything like a consensus on
how this should be approached. It’s about having a framework that makes
sense. It isn’t about annoying the US.”
Morningstar also said
operating an ESG model for developed-world debt was difficult because
advanced countries tended to share many similarities, lacking the wide
dispersion in macroeconomic conditions and risk/return profiles
witnessed in emerging markets.
Yet even in emerging markets
ESG-based sovereign bond investment can be problematic. Morningstar said
that ESG assessments tended to be based on social and macroeconomic
indicators, such as data on labour markets, educational standards and
social mobility.
9%
Proportion of passively managed ‘sustainable’ money in bond funds
This means middle-income developing countries such as Poland, Chile and the Czech Republic are rated more highly than the likes of Bangladesh, Nigeria and Ivory Coast.
ESG
investing therefore risks starving the countries arguably most in need
of funding and instead lending more to those that already have better
access to markets, unless the ESG rating is explicitly adjusted for each
country’s level of development.
“The link between ESG scores and
per capita GDP is strong. How can you reconcile a focus on ESG
principles with investments in emerging and frontier markets that are,
almost by definition, less well governed, more corrupt and increasingly
more polluted than developed markets?” said Charles Robertson, chief
economist at Renaissance Capital, an emerging markets-focused
consultancy.
22%
Proportion of ‘non-sustainable’ passively managed money in bond funds
As a result, and despite the relative ease of operating an ESG
approach to corporate bonds, fixed income funds account for just 9 per
cent of passively managed “sustainable” money. In comparison, bond funds
constitute 22 per cent of mainstream “non-sustainable” passive
investment.
European investors have just 53 passive fixed income
funds to choose from, Morningstar found, while there are only 12 aimed
at US investors, out of the 534 “sustainable” index-tracking funds
available globally across all asset classes.
As a result, fixed income funds have largely missed out on the recent sharp inflows into passive ESG.
However
Amin Rajan, founder of Create Research, a consultancy, argued that
there was simply a lack of interest among institutional investors in
government bonds at the moment, due to yields being at record lows and
the perception that sovereign debt no longer provides the same
diversification benefits that it once did.
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