Global assets in ESG bond funds have tripled in three years to $350bn, driven by increased investor awareness of sustainability risks and opportunities and a desire to make a difference.
At the same time, access to more and better-quality ESG data has allowed asset managers to innovate and create more suitable and targeted products.
Product development has started to accelerate, with the launch of 122 new ESG bond funds last year and an additional 45 funds that switched from a conventional to a sustainable mandate. This brings the total ESG bond funds universe to 900 globally, as of March 2021.
However, ESG bond funds still account for less than one fifth of total ESG fund assets, despite fixed income representing 27% of the overall fund market.
Europe and the US
Europe and the US have had the highest level of adoption of ESG bond funds, but Europe largely dominates the space, accounting for nearly 90% of all assets globally. This is slightly higher than Europe’s share (83%) of the overall ESG fund market.
Europe’s advantage in sustainable investing appears to be driven at least in part by local investor preferences. For example, Norway’s sovereign wealth fund has developed sustainability criteria within its investment objectives, setting a standard for other large domestic asset owners to follow.
Additionally, the 2015 Paris Climate Accord established greater sustainability-related disclosure requirements in several countries such as France and the Netherlands, followed by the release of the EU Action Plan on Sustainable Finance in 2018, which has accelerated the adoption of ESG strategies by institutional investors across Europe. Institutional money has flown into sustainable fixed income funds at an accelerated pace with retail investors contributing to this growth, though to a lesser extent.
While the two largest ESG bond funds are domiciled in the US, the US sustainable fund market continues to lag Europe, largely owing to the political and regulatory environment. US regulation has fluctuated between a neutral stance and open discouragement by the previous Trump Administration.
In addition, there has been substantial scepticism in the US regarding the correlation between ESG factors and performance despite a growing body of research showing that the integration of ESG factors into an investment process can lead to lower spreads, better credit ratings for corporate bonds, better performance, and lower credit risk for sovereigns.
Outside Europe and the US, assets in sustainable fixed income funds are also increasing but from a very low base.
Passives and impact
Although the vast majority of ESG bond funds are actively managed, passive offerings, especially exchange-traded funds, are rapidly catching up, with their market share having grown from just over 5% two years ago to 14%. Also, the largest green bond fund is the Irish-domiciled iShares Green Bond Index Fund, with $3.7bn of assets.
Impact bond funds are on the rise, now accounting for 10% of the ESG bond fund universe. They primarily invest in fixed income instruments specifically earmarked to raise money for environmental and social projects that create measurable societal outcomes and are aligned to the UN Sustainable Development Goals. These include green, social, and blue bonds, but also muni bonds and other type of impact bonds. Green bond funds are by far the most popular investment vehicles to achieve impact, with around $25bn of total assets.