Unpacking 2 Paradigm Shifts

[This article appears in our November/December 2021 issue of ETF Report.]

It may be hard to look away from all the action—and the attention—that crypto assets get these days. But if you do, you’ll find that fixed income and ESG are the other topics du jour in the asset management industry. And for very different reasons.

Fixed income, in a nutshell, just isn’t doing what it’s historically done, largely because interest rates have been at rock-bottom levels for such a long time. ESG, meanwhile, is gaining attention because climate change, as predicted by many scientists, is becoming a very real threat to human existence, and social issues rank high in everyone’s minds these days.

Restoring Fixed Income’s Role
Although fixed income has been misbehaving for over a decade, raising interest rates could go a long way to restoring its traditional role as a source of income and ballast in a portfolio. The Fed has indicated it intends to do just that—though the exact timeline and degree are still a question mark.

Even if that doesn’t do the trick, investors have other choices to consider in their search for income and stability. Options strategies, preferred stocks and pass-through securities can all add income and diversification to a portfolio’s bond allocation. There are also defined outcome ETFs that protect against downside losses up to a certain point in exchange for accepting more muted positive returns.

Low interest rates have immediate and clear ramifications for retirees, but the implications of artificially tamping down on them extend like subtle tendrils to other areas of the economy, like a highly unpredictable but slow-moving Rube Goldberg machine.

ESG To The Rescue?
Given the past few years of rising temperatures, epic wildfires and flooding around the globe, it’s not surprising the world is suddenly paying attention to climate change and very concerned about the “E” in ESG.

That’s not to say the other pillars aren’t important. Corporate governance is still a concern as it ensures that capitalism works, and does so as fairly as possible, and social issues have come to the forefront with the rise of Black Lives Matter and other human rights movements. Indeed, recent surveys have concluded that social issues are actually the biggest concern for ESG investors. However, climate change is literally about the air we breathe. Ultimately, an uninhabitable planet benefits absolutely no one.

One could also argue that the “E” is a crucial element of the other two letters in the acronym. After all, from a social perspective, marginalized populations tend to be disproportionately affected by climate change and have fewer resources to address it. And given that something like 100 corporations account for more than 70% of carbon emissions, governance can have a meaningful impact on climate change depending on how a company chooses to address it.

Of course, ESG investing practices alone will not fix climate change, but given enough momentum and enough investment dollars, they could help move the needle to where we need it to be. Given the powerlessness of the average person in the face of global trends, ESG investment strategies give every investor the ability to let their portfolios be their voice.

Change Dominates
The disruption in fixed income and the rise of ESG investing both represent paradigm shifts in their own ways.

The former may be reversible. If it’s not, the ingenuity of the financial industry will likely generate an acceptable solution to the persistent income problem and other related ones before long.

The latter, however, is a permanent change—a genie that will not return to its bottle. Most market participants expect that ESG criteria will be incorporated across the investment space and become the standard in most investment approaches in the near future. To use an overused term, we may very well be at the early days of our “new normal”—whatever “normal” means in the face of constant change.