Bond funds represent a small percentage of the overall universe of environmental, social and governance (ESG) funds. When it comes to ESG exchange traded funds (ETFs), fixed income is also a small, but growing part of that space.

While the idea of socially responsible investing (SRI) is not new, it is new within the bond ETF landscape. That newness is not stopping some industry observers from forecasting significant growth ahead for socially responsible and sustainable bond ETFs. Importantly, the potential for ESG fixed income growth could be widespread across corporate bonds, sovereign debt and other parts of the bond market.

“MSCI found a significant difference in performance between government bonds with similar credit default swap (CDS) spreads but different ESG ratings,” according to International Adviser. “Since 2011, those countries with higher ESG ratings have seen their CDS spreads fall by more than countries with relatively low ESG ratings, MSCI has found. This relationship holds for all government bonds, apart from those that have Aaa ratings with CDS spreads below 50 basis points (bps).”

Where ESG Exists With Bond ETFs

Existing ESG bond ETFs take approaches to responsible and sustainable investing. Several of these products are also still in their infancy. For example, the iShares ESG USD Corporate Bond ETF (SUSC), which debuted in July, which “seeks to track the investment results of an index composed of U.S. dollar-denominated, investment-grade corporate bonds issued by companies that have positive environmental, social and governance characteristics while exhibiting risk and return characteristics similar to those of the parent index,” according to iShares.

SUSC holds just 191 bonds, indicating that only a small percentage of U.S. corporate bonds meet the ESG criteria set forth by SUSC's index. To the point of credit quality, SUSC is highly rated as 89% of its holdings are rated A or BBB.

ESG investing principles can also be applied to a broader universe of bonds. Take a look at the Nushares ESG U.S. Aggregate Bond ETF (NUBD). NUBD, which debuted at the end of third quarter, follows an index comrprised of “U.S. government securities, debt securities issued by U.S. corporations, residential and commercial mortgage-backed securities, asset-based securities and U.S. dollar-denominated debt securities issued by non-U.S. governments and corporations,” according to Nuveen.

Obviously, NUBD is a new ETF, but it is off to a solid start with more than $42 million in assets under management.

The Sage ESG Intermediate Credit ETF (GUDB) is a corporate bond fund tracking the Sage ESG Credit Intermediate Index. GUDB holds 103 corporates, over 94% of which are rated AA, A or BBB.

Forecasting Growth

There is ample room for growth among ESG bond ETFs.

“As evidence of the opportunity for investors and fund issuers alike, research from Sage Advisors said only 0.5% of fixed-income assets in the U.S. Morningstar fund and ETF universe are aligned with ESG, compared to 1.7% of equity fund assets,” reports Pensions & Investments.

New types of ESG bonds could spur the creation of more socially responsible bond funds. Indicating that the VanEck Vectors Green Bond ETF (GRNB) could be at the right place at the right time, green bond issuance topped a record $100 billion this year with that number expected to continue growing in the years ahead. Green bonds are issued by companies with the proceeds directed at an environmentally friendly projects.

Recently, a U.S. dollar-denominated issue was launched in Australia aimed at workplace gender diversity. The issue was over-subscribed, indicating investors' interest in ESG bonds is international in nature. As is the case with equities, investing in bonds issued by companies prioritizing ESG principles can be rewarding for investors.

“Bank of America Merrill Lynch research has found environmental, social and governance (ESG) factors to be the single best signal of future risk; such criteria would have helped investors avoid 15 out of 17 bankruptcies the bank studied since 2008,” according to Reuters.