Sustainable fixed income funds are a small segment of the impact market today, but one that is growing, finds Morningstar in a new study. Of the $1.8 trillion in sustainable assets the ratings group follows, $375 billion of that were fixed income based.

The firm’s latest report, A Primer on Sustainable Fixed-Income Funds, describes three key ways U.S. and European asset managers are utilizing ESG fixed income investing. These findings are based on conversations with a dozen or so managers, Morningstar stated. The report also looks at several fund firms and what they offer and where they fit in these descriptions:

  1. ESG Consideration

This is toe dipping into ESG; where criteria is used for the investment decision-making process, but not usually at the portfolio level. “The prospectus generally implies that ESG factors don’t make or break an investment decision,” Morningstar states.

That said, Morningstar sees this growing as the demand for ESG investing grows.

  1. ESG Focus

A broader view that integrates ESG criteria that follow more stringent measurements throughout the process and should be more attractive to those clients wanting to focus on this space, Morningstar notes.

These fund managers not only focus on selecting securities that follow sustainability practices, but also avoid those that don’t.

  1. Impact investing

These are the all-in managers, those that put environmental and/or social goals “front and center,” according to Morningstar. Taking an activist approach, these fund managers will invest directly in bonds that finance affordable housing, community development, green energy priorities, green infrastructure or other sustainable areas.

Morningstar did find that investors need to be careful when investing in ESG fixed income funds, as “there’s a lack of standardization around them, hard-to-measure environmental and societal goals, and difficulty in evaluating the degree to which ESG is truly integrated in the strategy,” the firm noted.

(Related: How to Avoid Greenwashing)

It also noted that, especially in the bond market, some investor ESG goals may be hard to attain, especially with high-yield bonds, which are less available. Managers, it states, will need to throw a much wider net to find more issues. Relying on repackaging older, underperforming funds won’t work.

Further, Europe is ahead of this fixed income ESG investing curve, states the report, “with more open-end and exchange-traded strategies available than other regions and many firms setting significant ESG-related goals.”

In fact, “over the past three years ended June 2019, European investors poured $34 billion into sustainable fixed income funds. Roughly three fourths of these strategies were domiciled in Europe, which accounted for two-thirds of the assets, with U.S.-domiciled funds accounting 13% of this universe but close to one-third of the assets. “

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