The Next Area of ESG Investing Growth?

401k, retirement, ESG, Cerulli

It's getting bigger.

Environmental, social, and governance (ESG) investing is a growing force in the defined contribution space, and overwhelmingly relegated to the equity space.

Yet as interest in ESG fixed-income opportunities rise, demand is beginning to outstrip supply, according to research and consulting giant Cerulli Associates.

The firm’s research shows an increase in demand for ESG in all segments of the fixed-income market, and it expects to see the launch of a variety of new ESG products over the coming years, including in areas less suited to ESG, such as high yield.

Cerulli notes that the incorporation of ESG criteria into fixed income has been hampered by factors such as the role of ESG in credit ratings, the shortage of sustainability indices against which to benchmark performance, the scarcity of ESG-focused products and the challenges of engaging with issuers—particularly sovereigns.

The key difference between the ESG needs of a fixed-income investor and those of an equity investor is that the former is focused on managing downside default risk, whereas the latter’s priority is upside appreciation.

“The inclusion of ESG factors in fixed income is becoming more widespread, with ESG data and ratings now available for most investment-grade credit issuers, as well as a large proportion of high-yield issuers,” Ilonka Oudenampsen, senior analyst of European institutional research at Cerulli, said in a statement.

“In addition, there have been several important innovations in the fixed-income space, including the rise of green bonds and the emergence of social bonds and bonds linked to the UN’s Sustainable Development Goals.”

At less than 0.1 percent of the total global bond market, the labeled bond market is too small to meet investor demand.

Social bonds and bonds linked to the Sustainable Development Goals are still new to the market, but Cerulli expects more of these types of product, as well as green bonds, to be launched as investor demand continues to grow.

“ESG integration into fixed income is relatively new, so many institutions rely on their asset managers for suggestions. Managers should, therefore, expect to spend a significant amount of time gaining an insight into their clients’ views on ESG in order to devise suitable solutions,” Oudenampsen concluded.

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