Bond issuers that score well on ESG criteria could attract more capital inflows, Hooper added, “which, in turn, could lead to better performance.”
Hooper cited Russian sovereign bonds as an example of how ESG screening can avoid losses. Before Russia invaded Ukraine on February 24, Russia was considered a creditworthy emerging market issuer due to its natural resource revenues and foreign currency reserves.
“From a financial credit perspective you might have included it, but from an ESG or operational or quality factor you would have excluded Russia,” Hooper said. ESG “turned out to be a very good variable, a good factor to add, in the investment process”.
Hooper said fixed income portfolio managers need to stay mindful of traditional credit analysis. “First and foremost, you can’t get away from the fact that the business has to be financially viable,” Hooper said. “The ESG part, or the operational part of this business, is not enough.”
Invesco Canada sponsors the Invesco ESG Canadian Core Plus Bond ETF, also offered as a mutual fund, and the Invesco ESG Global Bond ETF. These funds are part of more than 40 socially responsible ETFs and fixed income mutual funds in Canada. Around 20 fund providers offer mandates ranging from broad ESG to a narrow low-carbon focus.
Although funds like the Desjardins SocieTerra Canadian Bond Fund and the RBC Vision Bond Fund have longer track records, most mutual funds and nearly all ETFs with ESG-related fixed income strategies have less of three years. This proliferation responds to increased awareness and growing investor demand for value-based investing.
Fixed income strategies fall into two main types: those that follow the indices and those that are actively managed. One of the most comprehensive ranges is ETFs from BMO Investments Inc., which includes Canadian corporate bonds, US corporations, global bonds and high yield bonds.
BMO’s passively managed ESG ETFs in fixed income categories are based on MSCI ratings that specifically exclude certain industries, including alcohol, tobacco, adult entertainment, gaming, weapons and energy nuclear. Also ineligible are companies that the index provider deems to be involved in “serious business controversies”.
BMO’s latest ESG offering is the actively managed BMO Global Sustainable Multi-Sector Bond Fund, available in ETF and mutual fund versions. Investors approved an amendment to the fund’s mandate, effective November 2021, to add sustainability criteria to the fund, which launched in 2018 without an ESG mandate.
With the notable exception of openness to nuclear power, the global fund’s exclusions are similar to those of BMO’s ESG index funds, said Mark Raes, product manager at BMO Global Asset Management Canada. Otherwise, the fund’s portfolio management team uses a ranking system to select socially responsible companies while avoiding ESG laggards.
“When we think about ESG screening, measurement and screening, there’s an element of quality to that,” Raes said. “And there is an element of risk mitigation. This is something that obviously works very well, along with active management.
BMO is the only company to offer ESG ETFs in the high yield category — one currency hedged and one unhedged. There’s more opportunity for ESG to have a positive impact on lower-quality bonds, Raes said: “You may be dealing with companies that are emerging or that may have had governance issues. in the past.”
Invesco’s national and global ESG strategies are both actively managed, with screening consisting of specific sector exclusions and a proprietary rating system that rates other issuers.
Fixed income analysts from the Invesco organization in North America and abroad are responsible for assessing financial and ESG criteria. “We think being really candid about ESG fixed income investing, it needs to be done by credit specialists,” Hooper said. “These are individuals or analysts who are closest not only to the industry but also to the respective issuers.”
In the Canadian bond market, where domestic fund managers have far fewer choices than their global counterparts, ESG mandates will limit security selection.
But since only 26% of the Canadian investment-grade universe is made up of companies, exclusions are not onerous. At Invesco, Hooper said, specific exclusions — primarily in the energy sector — represent only about a tenth of the company universe, or less than 1% of the entire Canadian market. In addition, a Canadian fund may invest up to 30% of its assets outside of Canada.
When it comes to the global arena, does ESG investing mean sacrificing fixed income returns?
“It’s the No. 1 question in responsible investing,” Raes said. “And fortunately the answer is no. The investment universe is still very broad. And, second: “People recognize the element of risk that is mitigated by an ESG overlay or screen.”