Building a Sustainable Portfolio? Don't Forget Your Bond Funds

Giovanni Cafaro tells about recent developments in the European corporate bond fund market, keeping a keen eye on sustainable offerings

Ollie Smith 14 April, 2023 | 9:50AM
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Ollie Smith: Now you're used to hearing about sustainability from the perspective of equity funds, of course, but Morningstar fixed income fund analyst Giovanni Cafaro's here to remind you that there are other types of sustainable funds too. Giovanni, thanks for joining me. What developments are you seeing in the euro corporate bond fund market when it comes to this topic?

Giovanni Cafaro: Good morning Ollie. Thanks for having me today. So first of all, compared to other regions, Europe has a highly developed market for ESG label bonds, which sustainable euro corporate bond funds typically invest in. These bonds are usually referred to as GSS bonds, which really stands for green, social and sustainability bonds. And this market has evolved rapidly in recent years and to put that into context, GSS bonds actually represented around a third of European investment grade bond issuance last year, in 2022. Green bonds are a fast growing subset of this category and are issued to finance projects or activities with positive environmental impacts. Actually, the Morningstar euro corporate bond category and its respective short term category currently has around 15 funds which are specifically focused on green bonds. And sustainability linked bonds have also gained popularity more recently and their share of issuance has increased quite significantly since the pandemic and these bonds are structured in a way to link the issuing company's achievement of sustainability goals to actual financial incentives and actually impose penalties on issuers that are not able to meet those goals, typically through copying and linking the coupon of the bond.

So overall, as a result of these developments we've seen in the market, we've seen that the Morningstar euro corporate bond category also evolved rapidly in recent years through either new sustainable fund launches or strategies that started to incorporate ESG factors into their investment processes and currently almost one-third of the funds in euro corporate bonds category are deemed as having sustainable focus and more than half of the funds that were launched last year in 2022 were actually explicitly targeting ESG objectives.

OS: Sure. So let's start looking at some of those funds, tell me about BlackRock first and foremost.

GC: Sure. The first fund, I'd like to talk about today is the BlackRock Sustainable Euro Corporate Bond Fund. This strategy really benefits from the experience and the depth of its management team, led by Tom Mondelaers, who's managed the fund since its inception in June 2019. As well as the more established core version of this fund since July 2009 is supported by Georgie Merson who was appointed co-manager in June 2021. So almost three years ago, and he provides expertise in non-financial sectors and sustainable investing. And the two were always really part of BlackRock's, well resourced, euro fixed income platform which is led by Michael Krautzberger.

When it comes to investment process, this is very much centered on BlackRock's typical relative value approach. ESG integration is well structured here. It begins with an exclusionary framework, which reduces the investment universe by approximately 15%. And more recently it has also incorporated more elements to it, including commitments to invest in green bonds, a targeted reduction in carbon emissions at portfolio level and an adoption of a proprietary framework that really allows for better assessment of externalities. So in essence, the cost or benefits of the company's operations to society. And both portfolio managers and research analysts integrate these insights and data into their investment process but can also leverage on a dedicated fixed income ESG team at BlackRock.

OS: Sure. And I believe for our second fund, we're going over to Schroders.

GC: That's correct. The second fund I'd like to talk about today is the Schroder Sustainable Euro Credit Fund. So Saida Eggerstedt she's the lead manager of the fund and has been in charge of the fund, since its inception in December 2019, she works closely with Patrick Vogel. He's a longstanding portfolio manager of the firm's flagship European corporate bond strategy and can leverage on Schroder's experience at European credit team, credit analyst desk as well as a growing ESG team. So the fund features Schroder's trademark thematic approach to corporate bond investing and credit analysis combined with the well thought integration of sustainability considerations. So as its name suggests, the fund predominantly invests in Euro denominated corporate bonds and aims to maintain a higher overall sustainability score compared to the benchmark as measured by the proprietary rating system. And this is achieved through a combination of sector exclusions on one end, but also with focus on sort of companies with strong or improving ESG characteristics. So as for the BlackRock funds I mentioned earlier, the investable universe of these strategy is reduced by approximately a fourth. Through a list of excluded sectors, for instance, coal burning utilities, or coal tobacco companies or gambling businesses. And the managers then aim to emphasize those that feature higher improving sustainability ratings, according to the credit analyst. So essentially, following your best in class approach.

OS: Sure. And then just finally with our third strategy, we're looking at an ETF, aren't we? But Morningstar thinks it's particularly well diversified. Tell me more.

GC: Sure. So the third fund is iShares EUR Corporate Bond ESG ETF and it is a really reliable passive option in the space which maintains good ESG credentials and combine broad diversification and attractive fee level. So this ETF tracks the performance of the Bloomberg MSCI Europe Corporate Sustainable SRI Index, which differentiates from its parent benchmark from being subject to ESG and ESG screening process. So this index includes investment grade euro denominated corporate bonds issued by companies with the MSCI ESG rating of BBB or higher, the index is constructed through a three stage screening process. That excludes issuers involved in certain sectors and those flagged for significant controversies, and then the eligible securities are then weighted based on their market value similarly to its sort of parent non-ESG benchmark and overall the portfolio shows good diversification across sectors and metrics, such as credit rating and maturity, and ESG filters typically deliver a quality bias to the portfolio as measures, especially in terms of its credit rating distribution, while also maintaining a similar risk reward profile to its non-ESG version.

OS: Fantastic. Giovanni, thanks so much for joining me. If you're interested in fund research and insights, check out Morningstar Direct, or indeed any of our international editorial websites. Until next time my thanks to Giovanni again. I've been Ollie Smith for Morningstar.

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Ollie Smith

Ollie Smith  is editor of Morningstar UK

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