Investors pile $54 billion into ESG bond funds in a fiery start to 2021

Investors poured $54 billion into bond funds specializing in environmental, social and governance issues in the first five months of 2021, even as concerns about potential “greenwashing” mounted.

After several years of plentiful sales From ESG-focused equity products, investors are now turning their attention to fixed-income funds, according to numbers compiled by Morningstar, the data provider.

In total, sales of all ESG bond funds were $54 billion in the year through the end of May, compared to about $68 billion for the whole of 2020. The data covers open funds and exchange-traded funds globally.

AUMs in products increased 14 percent to $374 billion between January and May, while nearly doubling in three years. In 2020 alone, assets are up 66 percent, compared to a 12 percent increase in assets for the entire fixed income fund.

Rising demand has led to a rush of new fund launches, while companies and governments have unveiled swathes of social and green bonds to take advantage of the trend. But the increased interest has raised concerns about so-called greenwashing, including concerns that some bond funds are not as sustainable as they claim, and that fund managers are finding it difficult to decipher their ESG adoption.

Jose Garcia Zarate, associate director at Morningstar, said there is “a clear trend in favor of ESG growth, particularly in Europe,” but that many fund managers are struggling with “how to apply ESG principles to specific bond markets.” He said the attempt to rank government bonds with ESG standards had proven “extremely disingenuous” as “there is still no consensus on how to go about rating governments and countries”.

Garcia-Zarate said the demand for ESG bond funds is concentrated in Europe, but other regions are starting to see interest. In the United States, ESG bond fund sales were $4.75 billion in the first five months of 2021, compared to $5.92 billion for the whole of last year.

There is also a growing demand for passively managed ESG bond funds, which typically track indexes. More than $17 billion has been invested in these products this year, beating last year’s record of $15.6 billion, according to Morningstar.

“ESG’s momentum is everywhere . . . it is not surprising that we are seeing the launch of funds,” said Colin Purdy, chief investment officer for liquid markets at Aviva Investors, which recently launched a bond fund focused on climate transition.

Morningstar data shows that 122 new ESG bond funds were launched last year, with 44 new offerings in the first quarter of 2021.

But Purdy added that there are challenges for fixed income investors when it comes to ESG: “There is a view that ESG is easier on equities and one of the reasons for that is data,” he said.

In areas such as high yield or emerging markets, which are typically speculative investments, disclosure of data about ESG remains an issue. “There are higher resource requirements in the credit to ensure you get the information you need,” he said.

Despite this, exporters were racing to market with a new tolerable debt. Data from BloombergNEF shows that $245.3 billion in green bonds was issued this year, $83.8 billion in sustainability bonds and another $129.2 billion in social bonds. In contrast, in the five months ending May 2020, $91.44 billion in green bonds, $15.21 billion in sustainability bonds and $27.87 billion in social bonds were issued.

A column chart of net assets under management ($ billion) showing bond funds benefiting from investor appetite for ESG

Brian Jones, who manages the Rathbone Ethical Bond Fund, one of ESG’s oldest and largest fixed income funds, said there has been a “significant oversupply” of green and social bonds in his 17 years running the fund.

He said the demand for ESG bond funds has been driven by a range of regulations, such as efforts in the UK to get pension funds to look at ESG’s impact on investments, as well as new groups of investors, such as millennials and younger investors who are interested in seeing their money do well as well as Earning returns.

Despite the rapid rise in demand for ESG bond funds, they still account for less than a fifth of total sustainable fund assets, according to Morningstar.

A survey of Nordic and Dutch investors conducted by NN Investment Partners in May found that nearly half of those surveyed say green bonds are their preferred fixed income option. About 81 per cent of pensioners in the Nordic countries and the Netherlands said they had already invested in green bonds.

But those surveyed also expressed concerns about companies being laundered with green, saying this was the biggest barrier to investment.

Simon Bond, director of responsible portfolio management at Columbia Threadneedle Investments, said that although there have been some cases where issuers have been accused of this, the problem has not been widespread. But Bond added that the growing interest in cleaning the environment is positive.

“That’s good. It shines light on that dark corner. It’s very hard to hide when you have that light shining in this corner of the ESG,” he said.

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