ESG-Backing Institutions’ Fave Allocation: Investment Grade Bonds

What do institutions devoted to sustainable investing prefer for their portfolios? Investment grade bonds.

Turns out that, in a survey of 80 midsized institutions, investment grade fixed income was used by 81% of environmental, social, and governance (ESG) adherents. Of course, they allocate capital to other asset classes, as well, but to a lesser degree. Those that use domestic equities amount to 73%, followed by non-domestic stocks at 69%.

For ESG-oriented institutions’ bond holdings, 72% were investment grade, which argues that the asset allocators don’t want to stray too far out on the risk curve. That allocation amounts to almost a quarter of total assets under management.

At the moment, investment grades aren’t tearing up the track. This year, the Bloomberg Barclays US Aggregate index (or the Agg), which tracks them, is down 3.2%. This has a lot to do with rising interest rates of late. But the longer-term view is better: Over three years, the Agg is up an annualized 5%.

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And why do these institutions opt for ESG? Nearly half (48%) of ESG-using respondents said it was to dovetail with their organizations’ values or as a means of helping the environment or society. And 22% of them thought it would bring the best returns. Enhancing returns and reducing risk were the top two most important goals.

“Institutions believe that adding ESG criteria to an investment grade portfolio can enhance resiliency and possibly performance,” said Andrew McCollum, head of investment management at Greenwich Associates. “In addition, investment grade portfolios represent a logical and relatively seamless starting point for the integration of ESG into their broader organizations.”

Propelled by tough market conditions in recent times, the study also found institutions are repositioning bond portfolios to attain several objectives, including capital preservation, diversification, income generation, liquidity, and risk management. Strategically, their allocations were positioned either to take on risk to secure a needed yield or else to slim riskier investments where they weren’t getting the rewards investors sought.

When looking to hire external bond managers, the study indicated, the institutions’ overall caution shone through. They generally went with those that outperformed during risk-off times, instead of those that did best under more normal conditions.

To Peter Coffin, Breckinridge’s president, “investment grade fixed income and ESG are a perfect pairing.” Investment grade paper allows investors to best measure risks, he said. “We’re encouraged to see that institutional investors are in fact leveraging investment grade fixed income as a foundation for ESG integration.”

By now, ESG’s ability to deliver superior returns is largely, although not exclusively, accepted in investing circles. Recent research from BlackRock and Bank of America shows that ESG investments outpaced their non-sustainable counterparts during the March 2020 market meltdown.

And Harvard Business School professor George Serafeim concluded in a study that ESG outperforms both in downturns and over the long term, which encompasses all manner of market conditions.