How Advisors Use ESG Bond ETFs

November 14, 2019 What types of ESG bond ETFs would you like to see that don't yet exist?

Philipson: We want more ESG ETFs that—instead of slavishly following an index—are more themed, which could allow us to more proactively place our clients' dollars into market segments they care about. Also, we use a lot of municipal bond ETFs, so I'd love to see an ESG-screened municipal bond ETF.

Arnold: If we could wave that magic wand to have any ESG-specific ETF, it would be in the multisector bond category. Nuveen did just roll out a high yield ETF [the Nuveen ESG High Yield Corporate Bond ETF (NUHY)], which we were excited to see. But we'd like to see something like the PIMCO Income Fund (PIMIX) or the Loomis Sayles Bond Fund (LSBDX), just as an ESG equivalent.

Klaassen: I'd like to see more bond ETFs that actually actively take a socially responsible screening approach, rather than the ESG overweight/underweight or best-in-class approach. I have a lot of clients with a very strict sense of what they want to own. They don't want, say, Exxon in their portfolios, even as an underweight. What steps do you take to avoid "greenwashed" investments, or investments that are ESG in name only?

Klaassen: That's something you have to be cautious about. Sometimes funds are flagged as ESG that aren't doing quite what our clients might like. For example, take GUDB. I had a long conversation with the portfolio manager of that fund about some of the oil company debt in its portfolio. I asked him, "why are those in there?" His answer was because it's good credit; they're good bonds. The manager's take on ESG is to overweight the good actors and underweight the low scorers—not exclude them, just underweight them. Nuveen does the same thing.

But one of the key things our clients want from us is an environmental sustainability focus. The vast majority of our clients do not expect to see Exxon-Mobil (XOM) in their portfolios. So, I have to be cautious about which model portfolios I use GUDB or NUBD for. You just have to be careful about how you're building your ESG portfolio, because there's a lot of nuance. And there are things you can do with individual securities that you just can't do with ETFs.

Philipson: Because our SRI criteria is so strict, I also started looking at the actual sponsors of ETFs, as well. I looked at how they behave.

For example, when I was digging into municipal bond ETFs, my first pick was a Vanguard municipal bond. Generally, I like Vanguard; they're very index-based, which I like, and they're inexpensive. But when I started digging into it, I found Vanguard is one of the largest shareholders of CoreCivic (CXW), a private prison company.

It's not Vanguard's fault, per se, since they're using the index-based approach. But when I create portfolios for my clients, we exclude everything that has to do with private prisons. We hate private prisons.

So, I went with PIMCO; because, as they only do fixed income strategies, they don't own any CoreCivic stock. I'm actively choosing not to give my money to Vanguard, even though I like their product, because I don't want to support their corporate behavior of investing their clients' money in CoreCivic.

The way we think about it is this: Money is a force, a power in the world. Capital creates more things. What do we want to create more of? And what do we want to starve capital from, and hopefully create less of? My clients and I do not want to create more for-profit incarceration of human beings. Any little action I can take that makes it harder to profit off of that, I'm going to do it. What advice would you give an investor new to ESG investing?

Arnold: "Don't let perfect get in the way of doing good." There's always going to be one part of a portfolio that a client may dislike for one reason or another. Maybe they don't want fossil fuel stocks, or maybe they don't want to invest in Treasuries.

Ultimately, the way we cover that is transparency. We let our clients know that we follow a best-in-class approach to investing, where we try to overweight good players and underweight bad players.

Ultimately, you can avoid those things completely, if you create very ultra-customized portfolios, but there are always trade-offs. You may not be able to build out as well-diversified a portfolio, or you may throw off the risk/return metrics.

Philipson: The amount of greenwashing in this space really bothers me. There are ETF sponsors out there that are just sort of slapdash labeling something as SRI or ESG, though it happens more in the equity space than in fixed income.

I would encourage your readers to truly look at the holdings and methodologies. Don't trust sponsors that are just saying, “We've got Sustainalytics or MSCI data.” You need to know your ETF's holdings, because they're your holdings and your clients' holdings, as well.

Contact Lara Crigger at [email protected]

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