PIMCO, iShares ESG Bond ETFs Beat Their Dirtier Sister Funds

Several ESG short-term bond ETFs have performed better than their non-ESG sister funds in the past year, either because of or despite what they’ve taken out of their portfolios, according to new analysis from Todd Rosenbluth, head of ETF and mutual fund research at CFRA, a fund research firm.

The two short-term bond maturity ETFs Rosenbluth analzed are PIMCO’s Enhanced Short Maturity Active ESG ETF (EMNT) and iShares ESG Aware USG Corporate Bond ETF (SUSC), which ended up outperforming their non-ESG sister ETFs in one-year returns as of April 28, Rosenbluth found.

“I was surprised by the findings, given how different the ESG funds are, primarily in terms of what they’re pulling out of their portfolios. Investors in these funds are getting the same quality portfolios as they would in their sister funds, but they’re put through ESG filters and that’s a good thing if investing in ESG matters, or even if it doesn’t, in these cases,” Rosenbluth told Financial Advisor magazine.

Despite a narrower investment universe, EMNT essentially matched MINT in 2020, rising 0.06% compared to a 0.02% decline for MINT, partially because of EMNT’s lower expense ratio (0.27% vs. 0.37%), Rosenbluth found.

Year to date through April 28, SUSC’s 3.9% decline was less than similar iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)’s 4.8% loss, even though SUSC charges a slightly higher 0.18% expense ratio, the analyst reported.

“We aren’t making the case that investors should buy an ESG bond fund in an effort to outperform the broader bond universe, although they could. Our case is if you wanted to build an ESG-oriented portfolio, you aren’t giving up much or, in these cases, anything.  If matching your goals with an ESG approach is important, you should have confidence with these ETFs,” Rosenbluth said.

Beyond holding their own in the past year, the differentiator in these ETFs is their ESG filters and screens, he saiid. EMNT launched in December 2019 with the same top-down focus as $15 billion MINT and has a nearly identical average duration of 0.7 years. However, EMNT has just 152 holdings, a fraction of MINT’s 770, due to the exclusion of dirtier sectors like alcohol and tobacco. The fund also uses a proprietary ESG framework to reduce carbon intensity and advance other social and sustainable priorities. At the end of March, EMNT owned bonds from just 62 corporate issuers, 40% of the number of MINT’s total positions, CFRA reported.

“The corporate bonds inside EMNT garnered an average ESG score of 7.1 (out of 10) from independent research provider MSCI, favorably higher than MINT’s 5.7. MSCI rates companies based on their exposure to industry specific risks and their ability to manage those risks relative to peers,” Rosenbluth said.

EMNT owns bonds from utilities that support renewable energy and tends to avoid sectors with structural challenges from an ESG perspective, such as the oil and automotive industries, he said. Beyond investment-grade corporates, EMNT’s portfolio managers have emphasized bonds from agencies that support home ownership, including for underserved communities, while promoting responsible lending and limiting investment in companies that use predatory lending practices. In addition, the fund invests in what management believes are attractively priced sovereign and corporate green bonds that address climate change and support leading environmental practices, according to CFRA.

“The same team runs both PIMCO ETFs but uses different criteria for security selection. EMNT’s also rates higher with CFRA because it “reflects our view that given the low-rate environment, additional risk taking is likely to be rewarded over the next nine months. However, for investors seeking capital preservation, it is a solid ESG-based offering,” Rosenbluth said.

SUSC could be a replacement for its widely known investment-grade corporate bond ETF LQD, he added. “We think the $42 billion index-based LQD has many favorable attributes, but for some investors the fund’s average MSCI ESG Score of 6.5 and modest ownership of bonds issued by makers of controversial products like nuclear weapons and tobacco is a concern.”

SUSC does not own such companies and receives an MSCI ESG Score of 7.6. “More appealing,” Rosenbluth said.

SUSC owns bonds from issuers that have relatively strong ESG attributes, including AT&T, Citigroup, and Microsoft, he said. SUSC recently had a 6.8% weighting in energy bonds, below LQD’s 8.6% stake. Meanwhile, with an average duration of 8.2 years, SUSC incurs less interest rate risk than LQD with an average of 9.4 years. SUSC and LQD track benchmarks from different index providers but have just over half of its assets in BBB-rated bonds.

“EMNT and SUSC are delivering solid performance in 2021 despite restrictions on what they own, but it’s important to make use of ETFs’ transparency and look inside to see what such funds own,” Rosenbluth said. “As more investors seek to align their societal goals with their financial objectives, we think it is important to make use of ETFs’ transparency to see and understand what is and is not inside ESG ETFs.”