A quick note: To highlight the SNW Impact Strategy through 2019, we will be periodically sharing thoughts and observations from the team responsible for the research and ratings. These pieces are intended to share the context of how the ratings are derived, the philosophy behind ESG and impact ratings, and how the industry is currently positioned. They may feature entities that we do not currently invest in.
You often hear it said that the first step is the hardest. But for investors and financial advisors looking to step onto the path to ESG and Impact investing, the first step can be an easy one—municipal bonds. Municipal bonds serve as a low-risk, tax efficient asset class that can dampen overall portfolio volatility and provide income. In addition to these favorable investment characteristics, when evaluating ESG and Impact opportunities, municipal bonds should be one of the first sectors that springs to mind.
Asset Class Characteristics
Most sectors of the municipal bond market, including tax-backed general obligation (think states, cities and counties) and various revenue-backed sectors (think utilities, hospitals, etc.), are amenable to ESG and value alignment investment approaches. Sectors such as education, healthcare, housing and utilities all have positive impacts, which investors pursuing such strategies will find attractive. The ability to invest directly in communities, in school systems, in renewable energy products, in clean water and in scores of other initiatives financed through the municipal bond market is a strong motivator for those seeking to achieve positive social and environmental outcomes with their investments.
That said, not all municipal bonds are impactful or ESG positive. Bonds financing prisons, detainment centers, fossil fuel power generation, hotels, shopping complexes and the like are also included in the municipal bond market. Even in sectors where a positive impact is possible, it takes a robust data collection and analytical effort to select bonds that achieve exceptional outcomes for the communities they serve. It takes an experienced team to evaluate the opportunities available and find those that are best suited for an ESG and Impact investing strategy. ESG factors that are material and relevant to the credit profile of an investment opportunity are integrated into any strong credit analysis; beyond this, identifying opportunities where financed projects can have a demonstrable positive effect on the surrounding community takes experience.
One common question we receive around ESG and Impact investing pertains to the amount of performance sacrifice for incorporation. Based on our experience, when managed properly, the answer is none.
For bond investors, keeping the primary risk factors (interest rate and credit risk) consistent between the ESG/Impact and non-impact equivalents in each of our strategies has resulted in comparable performance and volatility metrics. At its core, other than the ESG and impact focus of the securities selected, the strategies are almost identical, making it easy to use this asset class as an initial entry point into ESG and Impact investing.
ESG and Impact investing is a growth area, having seen a CAGR of 13.6% since 1995. As US SIF reported in its 2018 Report on U.S. Sustainable, Responsible, and Impact Investing Trends, "Total U.S. domiciled assets under management using SRI strategies grew from $8.7 trillion at the start of 2016 to $12.0 trillion at the start of 2018, a 38 percent increase. This represents 26 percent—or 1 in 4 dollars—of the total U.S. assets under professional management." As successful advisors already know, understanding the trends in the market and helping to lead client conversations to determine whether they are interested in participating are key.
Municipal bonds give financial professionals an easy way to begin the conversation, particularly when there are minimal differences in performance and volatility between the strategies. And for advisors using such strategies from SNW Asset Management, there are no differences in fees between the two options. This makes ESG and Impact investment grade municipal strategies an easy choice for that first step down the ESG and Impact investing path.
Source: SNW Research