24 Sep 2021

Inside ETFs: Credit ESG Gaining Traction

Contributor(s): Citi Global Insights
Demand for ESG exposure in bond portfolios is on the rise, leading to the development of a raft of new indexed investment options. A new report from Citi Research’s Kim D Jensen, summarized here, takes a close look at this burgeoning market.

Indexed ESG assets have tripled since Jan-20 and indexed ETF assets under management have quadrupled. ETFs also show signs of investors “switching” out of standard core ETFs into ESG replacements, particularly in credit ETFs.

According to Broadridge data covering over 13,000 fixed income funds, just over a quarter of these funds are marketed as offering ESG, and they manage $840 billion AUM (4.0% of total) and had $50 billion net inflows in the first quarter this year (12% of total).

The large share of flows means ESG is gaining market share and is up from 3% of AUM in 2016. Still, ESG adoption is probably further advanced for equity funds. Equity ESG funds manage around $2.5 trillion assets (6.8%). Only 10% of these assets are in indexed funds, but this type of fund has grown assets particularly rapidly.

Separately managed accounts control 12% of indexed assets and the remainder is evenly split between ETFs and mutual funds as of the first quarter this year. From that group, ETFs have displayed the strongest growth with their market share rising from 20% 5 years ago to 45% and absolute net flows in the last four quarters have been higher to ETFs than mutual funds. As of the first quarter this year, 21 ETFs managed $35 billion in fixed income ESG ETFs with 90% in European-listed funds.

Fixed Income Indexed ESG Asset Growth

European ETF Switching



Source: Citi Research, Broadridge Global Markets Intelligence

Source: Citi Research, Bloomberg


There’s evidence too of switching from non-ESG core ETFs to core ESG ETFs. As seen in the second chart above, ESG ETFs have had steady inflows totaling $8bn since Jan-2020. Meanwhile, non-ESG ETFs have fluctuated and currently have registered $4bn net outflows over the same period. This shows how investors using indexed fixed income products are switching existing assets and directing many new assets towards ESG enhanced products.

Active vs Passive

In general, counting both ESG and non-ESG funds, active management is more prevalent for fixed income portfolios than for equity portfolios. For equities 53% of assets are actively managed with 47% in indexed funds. For fixed income 81% of assets are actively managed and only the remaining 19% is indexed. This skew is even stronger for ESG funds. For equities, around 40% of assets are indexed, but in fixed income it is only 10%.

Active funds can adopt a strategy specifically focused on currently excluded companies that are about to experience a trigger for inclusion as an ESG investment or in an index. Such a strategy would be difficult to capture in a rules-based index. They also offer the possibility of combining the “simple” exclusion and inclusion methods from indexes to any given active bond strategy, e.g. relative value, liability matching or macro factor based.

A potential issue holding back indexed fixed income ESG is the choice of ESG scoring which arguably has developed with more of an equity investing focus. While there may be important overlaps it could boost indexed fixed income ESG if more fixed income specific ESG scoring methodologies were developed and used to create indexes. This would perhaps also make indexes able to capture something closer to the active ESG strategies.

A possible adaption of ESG scoring on issuer metrics only is to merge it with use-of-proceeds and sustainability-linked metrics, which is discussed more in the full report. Blending the two approaches could make for a more bond-specific ESG ranking. Such an approach could take account of the use-of-proceeds or sustainability-linked key performance indicators as well as other company level ESG indicators. For more information on this subject, please see EMEA ETF Perspectives - An Introduction to FI ESG ETFs, first published on Sep 10.

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

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