Sustainable global credit: Tailwinds on the horizon?

Morningstar’s Giovanni Cafaro looks under the bonnet of three sustainable bond funds

Giovanni Cafaro


Giovanni Cafaro, manager research analyst, Morningstar

Issuance of green, social and sustainability (GSS) bonds from corporates and the launch of new dedicated sustainable strategies both moderated in 2023 compared to previous years.

In this context, ESG regulatory uncertainty is another key factor which weighed on both investors’ and issuers’ sentiment. A series of tailwinds, however, could support the sustainable corporate bond universe and offer investors the opportunity to take advantage of relatively attractive yields compared to recent history while meeting their ESG requirements.

See also: – Sustainable bond issuance nears $1trn but avoided CO2 drops

Firstly, there continues to be strong demand for sustainable strategies. As per Morningstar’s latest Global Sustainable Fund Flows report, European sustainable funds across all major asset classes saw net inflows amounting $76bn during 2023, offsetting conventional funds which suffered annual outflows of $50bn.

Across Global Corporate Bond categories, 21% of net inflows during the year were driven by sustainable strategies. In recent years, particularly during 2021 and 2022, the number of sustainable funds in the space, both active and passive, has grown. This highlights a maturing segment of the fixed income fund universe and the diverse range of options available provides investors with more choice.

While sharing commonalities, the approach to implementing ESG elements in investment processes can vary significantly between funds. Sustainability can be incorporated, for instance, by the means of an exclusion policy based on sector, involvement in certain activities or breach of international norms, accounting for financially material ESG risk within issuer selection or setting a minimum allocation to ESG-labeled bonds.

Looking forward, if interest rates were to fall, it may boost bond supply. Lower borrowing expenses for issuers may serve as a tailwind for issuance volumes, especially if a “soft landing” scenario materialises, while increased investor interest could add to this dynamic. Such a more favourable capital raising environment could therefore be a catalyst for a pick-up in issuance volumes of GSS bonds. Corporates, banks and government-backed entities tend to dominate the space, hence this would help broaden the opportunity set for managers of sustainable credit strategies.

Our picks

The RobecoSAM Global SDG Credits fund benefits from the expertise of its portfolio managers, Reinout Schapers and Evert Giesen, with support from a wider group of experienced credit analysts, investment-grade portfolio managers, as well as a dedicated sustainability team. Building on the proven investment process of its sister fund, Robeco Global Credits, which earns an Above Average Process Pillar rating, this strategy combines it with a well-thought-out sustainability overlay. The team’s approach blends top-down positioning with fundamental bottom-up security selection, playing to the team’s strengths and resulting in a portfolio of around 150-200 names.

A distinguishing feature of the fund is the use of an internally developed three-step Sustainable Development Goals (SDGs) Framework. Only issuers deemed to have a neutral or positive contribution towards UN SDGs are eligible for investment. Typically, this criterion narrows down the investment universe by approximately 20-25% compared to its sister strategy. In-depth credit analysis allows them to assess the impact of financially material ESG risks on the issuer’s fundamental credit quality. The manager also allocates a minimum of 10% towards green, social, sustainable, and/or sustainability-linked bonds.

The PIMCO GIS Global Investment Grade Credit ESG fund, launched in 2018, is the sustainable version of the longer-standing flagship global corporate strategy, PIMCO GIS Global Investment Grade Credit, which has been running for more than two decades. Corporate credit specialist and sustainable credit expert Jelle Brons leads this strategy, drawing on the support of two co-PMs, Mohit Mittal and Mark Kiesel, PIMCO’s global credit CIO. The team, which is awarded with a High People Pillar rating, leverages on the support of a large team of 20 corporate-focused portfolio managers, more than 40 corporate credit analysts and traders as well as PIMCO’s dedicated ESG credit team.

Portfolio managers establish overarching themes and long-term ESG trends shaping the portfolio, while specialists search for bottom-up ideas. Overall, the firm’s exclusionary policy narrows down the fund’s benchmark universe by roughly 15%. The managers typically steer away from sectors including oil and gas, while showing a preference for financials and REITs, sectors with a higher prevalence of ESG bond issuers. The implementation of ESG criteria is underpinned by issuer-level ESG ratings and trend scores assigned by credit analysts based on a framework developed by the internal ESG credit team. At portfolio-level, the managers aim to maintain a higher average ESG score (as measured by MSCI ratings) than the benchmark’s by emphasizing names with either above-average or improving ESG profiles.

While this remains an asset class in which active managers have more ability to add value, passive funds offer a cost-effective option to investors seeking exposure to global credit with an ESG overlay. The iShares ESG Overseas Corporate Bond Index fund, which switched from core to an ESG-dedicated strategy in 2022, tracks the ICE ESG Global Corporate Ex GBP Index, which provides exposure to the global corporate bonds’ universe but excludes those denominated in sterling.

Starting from the non-ESG parent universe, the index employs Morningstar Sustainalytics ESG ratings to filter out issuers with higher unmanaged risk. Furthermore, the index removes issuers that derive part of their revenue from a list of controversial activities, including thermal coal, oil and gas, tobacco, and controversial weapons, including nuclear and small arms for civilian use. At portfolio-level, this approach typically leads to a bias towards bond issuers with higher credit quality, which can curb downside risks to an extent but also results in a lower yield compared with non-ESG peers.

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