Investors moving towards more sustainable fixed income allocations

Environmental, social and governance (ESG) and sustainable investing continue to gather strong momentum. What started out as an equity focused investment trend has been steadily broadening out across asset classes, as technology advances and more products become available.

Across the industry, sustainable fixed income indexing assets have more than doubled every year since 2018, as investors seek to move towards more sustainable fixed income allocations.

Sustainable ESG fixed income Exchange Traded Funds (ETFs) AUM globally (US$ bn)

Investors are under increasing pressure from today’s bond markets

Today, the challenges investors face in fixed income investing are three-fold: Capital preservation, diversification and income generation. In recent years, these outcomes have been made more challenging due to falling bond yields and lower for longer interest rates. Additionally, sustainable regulations such as Sustainable Finance Disclosure Regulation (SFDR) are becoming driving forces in how investors are building their portfolios.

Consequently, when investing in bonds through a sustainable lens, investors need to make sure they have all the building blocks available to them.

An indexed-approach to sustainable fixed income could help solve challenges

Sustainable fixed income Exchange Traded Funds (ETFs) offer a transparent and standardised approach to ESG investing. The rules-based methodology may give investors greater certainty as to which bonds they will be holding and the type of exposure they will be accessing. Importantly, the sustainability profile improvement can be very measurable. We believe an indexed-approach also goes hand-in-hand with the broader benefits of offering investors access, diversification and transparency, all at a low cost.

Additionally, what we have seen within sustainable fixed income indices is that they are not only the starting point for index investors but also for investors seeking above benchmark performance. We believe they are playing an important role in defining the investment universe.

Risk: Diversification and asset allocation may not fully protect you from market risk

Investors are considering a variety of approaches to incorporate sustainability in their portfolios

At BlackRock we see asset growth coming primarily from:

• Investors switching from non-ESG to ESG products to improve the sustainability profile of their investments using sustainable building blocks for core holdings
• Investors selecting one environmental (“E”), social (“S”) or governance (“G”) consideration and investing thematically, for example, focusing on climate change
• Investors seeking an impact investment approach such as green bonds: An impact investing approach seeks to generate a measurable, sustainable outcome, alongside a financial return.

Increasingly, as the range of sustainable fixed income products available expands, investors are using indexing to create sustainable fixed income portfolios, valuing the transparent, standardised, rules-based approach to sustainable investing.

Whilst asset growth is growing rapidly, if we look at the trajectory of sustainable equity index investing, we believe the trend towards sustainable fixed income indexing is just getting started.

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