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Research and analysis to keep sustainable investors up to-date on a broad range of topics That include trends and developments in sustainable investing and sustainable finance regulatory updates, performance results and considerations, investing through Index funde and actively managed portfolios, asset allocation updates, expenses, ESG ratings and data, company and product news, green, social and sustainable bonds, green bond funds as well as reporting and disclosure practices, to name just a few A continuously updated Funds Directory is also available to investors. This is intended to become a comprehensive listing of sustainable mutual funds, ETFs and other investment products along with a description of their sustainable investing approaches as set out in fund prospectuses and related regulatory filings
Growth of green bonds and green bond funds expected to reach new records: Green bonds volume expected to reach $250 billion in 2019 while green bond funds exceed $500 million
We are about to close calendar year 2019 with record green bond issuance that is expected for the first time to reach $250 billion worldwide, including an estimated $65 billion issued by various US corporations, financial institutions, state and local governments as well as in the form of ABS securities. At the same time, retail and institutional assets managed by US-based green bond mutual funds and ETFs that, in turn, invest in securities intended to finance projects with a positive environmental impact, are also expected to achieve another year-end record. Assets have already exceeded previous highs and in November reached $552.3 million. Also in 2019, the number of dedicated green bond fund has reached a new high with the latest launch of the Franklin Municipal Green Bond Fund by Franklin Templeton that brings the total number of available mutual funds and ETFs in the US to seven, up one this year, and a total of 20 funds/share classes. That said, green bond fund offerings differ from one another and as the number continues to expand and their track record seasons, the distinctions between them become more relevant for consideration by investors. This article examines four key qualities that portrays the differences between these funds, including investment strategies, fund expenses, performance results as well as disclosure of outcomes.
Growth of green bonds and green bond funds that now total seven funds/20 funds/share classes
Green bonds are bonds and related financial instruments that are no different than conventional bonds, except that their proceeds are earmarked and invested in various projects seeking to generate climate or other environmental benefits, such as renewable energy projects, various projects that seek to reduce greenhouse gas emissions, land conservation, and sustainable waste management projects to mention just a few.
So far this year through mid-December green bond issuance has already surpasses last year’s level to reach a new high of $231.2 billion. This represents a volume increase of $60.1 billion relative to last year’s $171.1 billion, for a gain of 35.1%. Green bond volume is expected to reach $250 billion by year-end, a new record that will add $78.9 billion if that level is achieved. Since their introduction in 2007 and continuing through mid-December, a combined total of about $758 billion in green bonds has been issued.
Unless there is a dramatic shift between now and year-end, a record in assets under management is also expected to be set by dedicated green bond funds in the US. These have reached seven in number, consisting of five mutual funds and two ETFs, with total net assets in the amount of $552.3 billion through November 29, 2019. This represents an expansion in assets by $264.5 million or 92% since the start of the year. In addition, new fund/share class launches in 2019 included the new to market Franklin Municipal Green Bond Fund with its four share classes as well as a new share class R6 added to the existing Calvert Green Bond Fund. Refer to Chart 1.
Assets invested in these funds are largely sourced to institutional rather than retail investors[1]. At the end of November, green bond assets under management sourced to institutional investors represented $416 million or 75.3% of green bond assets. This is up from $187.8 million at the end of 2018 at which time institutional investors accounted for 65.4% of green bond assets.
Green bond fund strategies vary across three strategy types
Seven green bond fund investment options are available to both retail and institutional investors. These include five actively managed mutual funds and two index tracking ETFs that can be further stratified into three broad categories: (1) Funds investing in green bonds across the globe, denominated in US and non-US currencies, issued by investment grade and some non-investment grade corporates, financial institutions, sovereigns, sub-sovereigns, supranational institutions, development banks, and various other types of issuers, including ABS securities. In each instance, non-US dollar risk may be hedged. For performance evaluation purposes, the ICE BofAML Green Bond Index-hedged USD Index is a useful benchmark, (2) Funds investing either entirely in US dollar denominated green bonds or exposures to non-US dollar green bonds are limited. These include the same US and non-US issuer types listed previously, however, the exposure to bonds denominated in non-US dollars may be more limited or avoided altogether, in which case the fund is not exposed to currency risk. For performance evaluation purposes, these funds are compared to the Bloomberg Barclays MSCI US Green Bond Index or an equivalent benchmark[2], and (3) Funds investing in US green bonds largely issued by municipal issuers, offering tax-exempt income. As of the date of this writing, only the Franklin Municipal Green Bond Fund, launched at the end of November, falls into this category. Refer to Table 1.
Within the constraints imposed on investors due to green bond issuance volumes, issuer types, sector, domicile, currency, credit ratings, and maturities, each fund manager has formulated its own proprietary green bond evaluation framework and investment selection criteria, including index tracking ETFs that default to the selection criteria imposed by the index provider. Above and beyond green bond selection criteria, three funds also superimpose additional sustainable investing considerations, such as environmental, social and governance (ESG) factors or more limited social filters. These are described in greater detail in Appendix 1.
Moreover, actively managed funds position their portfolio on the basis of geopolitical, economic and fundamental considerations. That said, there is a surprising degree of diversity in the securities holdings across the six funds. A total of 265 distinct issuers were held in the six portfolios as of September 30, 2019 and only three issuers are common to all funds, including Apple, Asian Development Bank and Bank of America. The levels of overlapping securities range from a low of 5.3% to a high of 61%. Refer to Chart 2.
Expense ratios fall within a wide range that extends from a low of 20 bps to a high of 1.11%
Beyond four funds/share classes that are subject to upfront sales charges of 3.75% or 4.25% and possibly a deferred sales charge, expense ratios for both institutional funds and retail-oriented funds fall within a wide range that extends from a low of 20 bps to a high of 1.11%.
Across the seven green bond funds, the two green bond ETFs are subject to the lowest expense ratios. At 20 bps, the ETF expense ratios are the lowest by wide margins even as compared to fees applicable to institutional-oriented green bond funds/share classes and significantly more so as compared to retail-oriented green bond fund offerings. When compared to the entire universe of fixed income ETFs, the expense ratios levied by these funds are below the average of 0.32% charged by the universe of fixed income ETFs but are 5 bps above the 1st quartile cut-off at 0.15% used in this research article as the lowest fee segment.
Institutional funds, defined here as funds that require minimum investments in amounts greater than $10,000, range from 45 bps to 71 bps. Directly sold and indirectly sold retail-oriented funds are subject to expense ratios ranging from 73 bps to 1.11%, however, four of the five funds that fall into this category also levy front-end sales charges of 3.75% or 4.25% and may also impose a deferred sales charge.
Lowest cost options for retail investors, those who invest directly rather than doing so via financial advisors or retirement plans, are limited to three lowest cost options, including the two ETFs at 20 bps each and the retail oriented share class offered by TIAA-CREF Green Bond Fund offered at 80 bps as it does not impose a sales charge. While the 80bps is positioned below the average for fixed income mutual funds, it ranks above the first quartile and is considered, for purposes of this research article, a moderate fee.
Total return performance results: Track record is limited but funds lag their designated benchmarks
The performance track record of green bond funds is limited. Of the seventeen funds/share classes available today only one fund, the Calvert Green Bond Fund, has achieved a three and five year track record. Launched in 2013, the fund has trailed its designated ICE BofAML Green Bond Index-hedged USD benchmark over the previous one-year, three-year and five-year time intervals. Excluding the impact of upfront sales charges, the fund lagged the benchmark over the last three and five-year intervals by an annualized average of 1.24% and 0.70%, respectively.
15 funds/share classes have established a performance track record covering a full trailing twelve-month cycle as of November 29, 2019. These funds generated an average return of 10.48% over the twelve month period, underperforming both the ICE BofAML Green Bond Index-hedged USD and the Bloomberg Barclays MSCI US Green Bond Index. This is also the case if one outlier result, explained below, is excluded. Still, results over the past year are clustered, with one exception, around the average and none of the funds, deviated from the average by more than 1%.
Further observations regarding the latest twelve-month performance results (Refer to Chart 3) are, as follows:
None of the 15 funds/share classes in operation for the trailing 12-months beat their designated benchmark.
Even as this is not their designated benchmark, for an additional comparison relevant to US intermediate investment-grade bond investors, six funds outperformed the Bloomberg Barclays US Aggregate Index.
The best performing fund/share classes are the AllianzGL Green Bond Fund Institutional and P shares, posting returns of 11.42% and 11.38%. The funds/share classes lagged the performance of the ICE BofAML Green Bond Index-hedged USD by 44 bps and 48 bps.
The next best performing fund is the iShares Global Green Bond ETF. The fund posted a return of 11.32%, trailing the index by 54 bps.
The remaining funds/share classes investing in US and non-US dollar denominated bonds registered results within 73 bps and 1.80% of their relevant index. At the same time, funds investing exclusively or largely in US dollar denominated bonds registered results within 0.99% and 4.69% of the relevant benchmark.
The VanEck Vectors Green Bond ETF was a performance outlier, falling short of its index by 4.69%. The fund registered the lowest return of 6.96% due primarily to negative currency returns. Since then, the fund has modified its investing approach by limiting green bond securities to US dollar denominated issues so as to eliminate the fund’s exposure to currency risk.
Reporting and Disclosure: Three funds produce useful impact reports
Thematic investors who invest for impact as well as financial results are likely to seek to understand the environmental outcomes achieved by their green bond fund investments, preferably in the form of measurable outcomes. Of the six funds in operation for at least a year, three funds produce useful impact reports that attempt to capture and disclose environmental outcomes. These include, for example, CO2 emissions avoided, air pollution reduced, energy saved, renewable energy capacity and generation, and water saved and treated, to mention just a few. The three funds that produce such reports annually, include: Calvert Green Bond Fund, iShares Global Green Bond ETF and TIAA-CREF Green Bond Fund.
[1] Defined here as funds with minimum direct investments ≥$10,000.
[2] VanEck Vectors Green Bond ETF seeks to replicate the performance of the S&P Green Bond U.S. Dollar Index.
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Last week BlackRock announced the launch of two fixed income ETFs, the iShares ESG USD Corporate Bond ETF (SUSC) and the iShares ESG 1-5 Year USD Corporate Bond ETF (SUSB). These are intended to track fixed income indexes designed to deliver similar risk and return characteristics as the traditional benchmarks but further qualified on the basis of constituent environmental, social and governance (ESG) scores while at the same time excluding certain companies from consideration. While not equivalent to a broad-based U.S. focused fixed income benchmark, such as the widely followed Bloomberg Barclays Aggregate Bond Index, these are the first of their kind passively managed fixed income ESG ETFs which are not even available as yet in the form of mutual funds. Just as significantly, the two ETFs are offered at the lowest expense ratios relative to other sustainable ETFs. The addition of these two fixed income ETFs brings to three the number of sustainable fixed income ESG oriented ETFs, with the first consisting of a green bond index ETF launched by VanEck in January of this year. The two new ETFs expand the roster of what is now a universe of 50 sustainable ETFs that have attracted a total of $5.6 billion in net assets as of June 30, 2017.
The BlackRock iShares Index ESG Fixed Income ETFs
The first fund, the iShares ESG USD Corporate Bond ETF (SUSC), seeks to track the investment results of the Bloomberg Barclays MSCI US Corporate ESG Focus Index which, in turn, is designed to capture the performance of U.S. dollar-denominated, investment-grade fixed rate and taxable corporate bonds that have remaining maturities of greater than or equal to one year issued by companies that have positive ESG characteristics while exhibiting risk and return characteristics similar to those of the Bloomberg Barclays US Corporate Index. As of May 31, 2017, the index included 2,297 issues from the following countries: Australia, Bermuda, Brazil, Canada, the Cayman Islands, Chile, Colombia, Curacao, France, Guernsey, Ireland, Isle of Man, Italy, Japan, Jersey, Luxembourg, Mexico, the Netherlands, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. A significant portion of the index consists of securities of financials and industrials companies. These had an average maturity of 7.15 years and the average credit rating was BBB+.
The second ETF, the iShares ESG 1-5 Year USD Corporate Bond ETF (SUSB), seeks to track the investment results of the Bloomberg Barclays MSCI US Corporate 1-5 Year ESG Focus Index that, in turn, is designed to reflect the performance of U.S. dollar-denominated, investment-grade corporate bonds with remaining maturities between one and five years and issued by companies that have positive ESG characteristics, while exhibiting risk and return characteristics similar to those of the Bloomberg Barclays US Corporate 1-5 Years Index. As of May 31, 2017, the index included 543 issuers with an average maturity of 2.74 years and an average credit rating of A-. A significant portion of the index is represented by securities of financials and industrial companies from the following countries: Australia, Canada, the Cayman Islands, Chile, Colombia, Curacao, France, Germany, Ireland, Italy, Japan, Luxembourg, Mexico, the Netherlands, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
Exclusions and ESG considerations
The two aforementioned indexes were developed by Bloomberg Barclays Capital Inc. with environmental, social and governance-related inputs provided by MSCI ESG Research LLC. The starting point for the construction of these indexes is the exclusion of securities of companies involved in the business of tobacco and controversial weapons companies, as well as securities of companies involved in very severe business controversies (as determined by MSCI ESG Research). Once these companies have been isolated, a quantitative process is applied to determine optimal weights for securities to maximize exposure to securities of companies with higher ESG ratings, subject to maintaining risk and return characteristics that are similar to the basic index.
For each industry, MSCI ESG Research identifies key ESG issues that can lead to substantial costs or opportunities for companies (e.g., climate change, resource scarcity, demographic shifts). MSCI ESG Research then rates each company’s exposure to each key issue based on the company’s business segment and geographic risk and analyzes the extent to which companies have developed robust strategies and programs to manage ESG risks and opportunities. MSCI ESG Research scores companies based on both their risk exposure and risk management. To score well on a key issue, MSCI ESG Research assesses management practices, management performance (through demonstrated track record and other quantitative performance indicators), governance structures, and/or implications in controversies, which all may be taken as a proxy for overall management quality. Controversies, including, among other things, issues involving anti-competitive practices, toxic emissions and waste, and health and safety, occurring within the last three years, lead to a deduction from the overall management score on each issue. Using a sector-specific key issue weighting model, companies are rated and ranked in comparison to their industry peers. Key issues and weights are reviewed at the end of each calendar year while corporate governance is always weighted and analyzed for all companies.
The Universe of Sustainable Exchange Traded Funds
As of June 30, 2017, a total of 50 ETFs pursuing sustainable strategies are listed on various exchanges and available to sustainable investors as well as other investors. These include 49 equity oriented ETFs and, until the introduction of the latest two funds, just one fixed income ETF that collectively pursue sustainable strategies ranging from exclusions of companies and sectors, to ESG integration, impact strategies as well as thematic orientations or sector themes, such as investments in water, solar, energy and wind energy. Some ETFs employ one of more of these strategies and their geographic focus may be limited to U.S. based companies or these may extend beyond the U.S. to encompass developed and developing countries in Europe, Asia and Latin America. Refer to Chart 1 for a breakdown of these ETFs by traditional category along with assets under management. At 20 offerings, ETFs focused on thematic sector investments are the largest in number. A total of 15 ETFs provide stock exposure to large capitalization, mid-cap and small-cap stocks in the U.S. while a total of 7 ETFs provide exposure to world stocks qualified on the basis of sustainable strategies.
Chart 1: Sustainable ETFs by Traditional Investment Categories and Net Assets
Even with these many ETFs, the sustainable ETF segment is highly concentrated, with only five ETFs accounting for 57% of net assets. Refer to Chart 2.
Chart 2: Five Largest Sustainable ETFs as of June 30, 2017
Sustainable ESG Funds Feature Higher Than Average Expense Ratios
Along with their sustainable strategies, what further distinguishes the two newly launched BlackRock ETFs and qualifies these as particularly compelling offerings for investors are their very attractive expense ratios. According to our analysis, the expense ratios of both funds fall into the lowest tier. The iShares ESG USD Corporate Bond ETF (SUSC) and the iShares ESG 1-5 Year USD Corporate Bond ETF (SUSB) are subject to expense ratios of 0.12% or 12 bps and 0.18% or 18 bps, respectively. These rank within the lowest or first quartile of expense ratios within the universe of 50 ETFs. For further information on the methodology used to stratify expense ratios, refer to the article Stratifying Expense Ratios: An Explanation.
In general, the universe of sustainable ETFs charges high average and median expense ratios of 0.48% and 0.46% or 46 bps, respectively. In fact, only 20 funds fall within the lowest expense ratio segment whose charges run as low as 0.20% or 20 bps. At the other end of the range, expense ratios are as high as 0.95%--a level that is exceedingly high for passively manage fund offerings.
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Vanguard Social Index Fund Summary
Assessment:High Conviction
Advised by the Vanguard Group, Inc., this index tracking fund offers an effective US equity-focused sustainable strategy that combines an exclusionary approach along with the integration of environmental, social and governance (ESG) factors. The fund has been in existence since May 2000, although its current underlying index, the FTSE4Good US Select Index, was adopted as of December 16, 2005. It is a liquid, large sized fund at around $2.9 billion that tracks the performance of a cross section of tradable US stocks with a combined retail and institutional investor base. Importantly, the fund is offered at a low fee (expense ratio) of 0.22% (Investor Shares) and an even more attractive 0.12% (as of December 22, 2016) for institutional investors subject to a minimum investment of $5.0 million (VFTNX). The fund has produced a strong track record relative to the non-ESG S&P 500 Index over the previous three and five years while lagging somewhat over the previous ten years due to poor relative performance in the early years. As an index vehicle, the fund also benefits from lower turnover (16% over the last physical year) and tax efficiencies.
VFTSX Review and Analysis
This $2.9 billion fund, advised by the world’s second largest asset manager with about $3.8 trillion in assets under management as of September 30, 2016, offers two share classes: Investor Shares subject to a $3,000 minimum investment and Institutional Shares subject to a minimum investment of $5.0 million. Originally launched in August 2000 to track the Calvert Social Index, the fund adopted the current FTSE index as of December 16, 2005.
The fund seeks to track the performance of the FTSE4Good US Select Index, a benchmark that is composed of the primarily large and mid-cap tradable stocks of US companies that are screened for certain social and environmental criteria, related to the environment, human rights, health and safety, labor standards and diversity. The fund attempts to replicate the index by investing all, or substantially all, of its assets in the stocks of companies that make up the index.
The FTSE 4Good Index is derived from a selection of constituents that comprise the FTSE ESG ratings universe. As of September 2014, FTSE implemented a new ESG assessment methodology. The new model contains over 300 Indicators, 14 Themes and 3 Pillars, including governance, social and environmental considerations. Environmental themes include climate change, water use, biodiversity and pollution and resources as well as supply chain considerations. Social themes include customer responsibility, human rights and community, labor standards, health and safety and supply chain considerations; and the governance theme includes corporate governance, risk management, tax transparency and anti-corruption.
Based on publicly available data, each company in the research universe is given an FTSE ESG Rating ranging from 0 to 5, with 5 being the highest rating. From June 2015 companies with an FTSE ESG Rating of 3.3 and above have been added to the index, subject to any additional requirements that comprise the overall methodology. FTSE intends to revise down the inclusion threshold to 3.0 over time. Constituents of the FTSE4Good Index with an ESG Rating below 2.5 are at risk of deletion from the FTSE4Good Index.
Companies which manufacture the following products are excluded from the FTSE4Good Index Series: Tobacco, weapons systems, components for controversial weapons; cluster munitions, anti-personnel mines, depleted uranium, chemical/biological weapons and nuclear weapons as well as coal companies. FTSE includes other screens around controversies, water, nuclear power and manufacturing of infant formula, to ensure that these meet certain health and safety as well as customer responsibility criteria.
Vanguard ESG Total Return Performance Results
Expense Ratios
The fund’s expense ratios covering both its Retail Shares and Institutional Shares are classified as lowest and lower, respectively. The Retail Shares expense ratio, at 0.22%, falls well within the first quartile and significantly below the median expense ratio of 0.55% for a universe of equity index mutual funds. The Investor Shares expense ratio, at 0.12%, is classified as moderate as it falls right on the 0.12% median expense ratio for institutionally oriented equity index mutual funds. Still, the fund’s performance over the last three-to-five years justifies its selection as a stand-alone product offering or a core component in a sustainable portfolio.
Bottom Line
This index tracking fund offers an effective US equity-focused sustainable strategy that combines an exclusionary approach along with the integration of environmental, social and governance (ESG) factors that are considered in a comprehensive and transparent manner. The fund has closely tracked the index, with a tracking error (R2) of 1.0. Importantly, it has delivered strong results over the last three to five years, bolstered by lower to the lowest expense ratios applicable to it's institutional and retail share classes. The fund qualifies as a core position in any sustainable investment strategy or a stand-alone holding.
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