The AGG Family is Growing–Sustainably

Matt Tucker: We just celebrated the 15th anniversary of the iShares Core U.S. Aggregate Bond ETF, or AGG, which sits at just over $56 billion in assets under management, as of October 31. Why did we decide to create another fund that seeks similar risk and return of  the Bloomberg Barclays U.S. Aggregate Bond Index?

Patricia Kao: It’s precisely because “the Agg” index is so pervasive that we wanted to tackle this exposure from a sustainable investing angle. This is also known as ESG, for environmental, social and governance. More and more people are looking to align their sustainability objectives with their financial goals, but don’t know how to go about it.

Along with the other products in our Sustainable Core suite, we wanted to provide an easy and seamless way to invest the way that people are already used to doing: aiming to track a widely followed market benchmark, but with a more sustainable footprint.

We found that U.S. investors are particularly sensitive to sustainable investing approaches that deviate too much from “market returns”–particularly on the downside. There’s still a perception that sustainable investing automatically requires you to sacrifice returns, but that doesn’t have to be the case anymore.

Matt: So what should investors expect with an ESG-oriented Agg index exposure? What do the ESG scores add?

Patricia: Well, the main point is that EAGG seeks a similar risk and return profile as the Agg index.

I’ll offer an analogy: some people prefer to buy and consume organic food. Even though an organic apple is nutritionally indistinguishable from a conventional apple, consumers might make this choice because they don’t want exposure to pesticides, or they want to minimize their environmental footprint. It’s very similar with our ESG-oriented Aggregate bond fund. It’s designed to look and behave a lot like the parent index. And, as Martin Small recently wrote about, ESG data can help to fill in some of the blanks left by traditional financial analysis–whether that’s putting an additional lens on hard-to-quantify risks such as governance, or simply because investors would prefer to see a “different” mix of names in their portfolios.

And the cost-conscious investor needn’t worry, unlike with organic food, ESG investing doesn’t cost an arm and a leg.  EAGG is priced at an expense ratio of just 10 basis points. [1]

Matt: So investment performance and sustainability aren’t an “either/or” proposition? How do we aim to do that?

Patricia: There are a lot of different approaches to creating sustainable portfolios. Some portfolio managers look to avoid the “worst offenders” or, on the flip side, invest only in specific projects with a defined (non-investment-related) social impact. EAGG’s index starts with a top level screen (e.g., weapons or tobacco), but most importantly we’ve designed our funds so that they seek a risk profile that is similar to the parent index of the fund’s benchmark. Consequently, it doesn’t require a compromise of return goals to choose an ESG investment.

To a lot of investors, fixed income is about downside avoidance–which actually fits nicely with an ESG approach. Academic empirical research is fairly sparse as this is still a developing field.

Matt: Let’s drill down a bit… how does our ESG bond approach differ from those used for stocks?

Patricia: That’s a great question. There has been a lot of attention paid to ESG in equity investing, but it’s still pretty rare to see viable solutions for ESG in fixed income. Which is interesting, because intuitively it’s a more natural fit. Bonds are just math. Unlike stock picking, it’s easier to replicate a bond portfolio outcome by substituting high-scoring ESG issuers for lower-scoring ones. For example, if you find a few five-year bonds with around 3.5% yield and single-A credit rating, you might overweight the one with higher ESG scores without altering the overall risk/return profile.

So we have similar objectives across our equity and fixed income funds–seek to replicate a market benchmark in an ESG-friendly way–but it’s easier to replicate in the bond space, in terms of the actual uplift to resulting ESG scores.

Matt: So how do we measure that uplift–how can you evaluate the impact of these funds?

Patricia: In addition to building EAGG and our other sustainable ETFs, we wanted to be able to demonstrate and quantify the impact of every dollar in each portfolio. With the launch of EAGG and iShares Sustainable Core suite, we’re introducing impact reporting on a fund-level basis, so you’ll be able to see top level ESG scores right away. EAGG’s first impact report is not yet available, but if we use the iShares ESG 1-5y USD Corporate Bond ETF (SUSB) as an example, we can see that it has an MSCI ESG Quality Score of 8.0, as of October 31. That’s versus 5.1 for its Bloomberg Barclays reference benchmark.[2]

Matt: What’s next for sustainable fixed income investing?

Patricia: ESG and sustainable investing have sometimes been painted as too niche, too expensive, too hard to measure, etc. But all that’s changing with new data and new products. I think we’ll see more innovation and more adoption of these new tools. We’re on the cusp of sustainable investing going mainstream, which is so fitting for ETFs and iShares. Fifteen years ago, we made the Agg Index accessible to all investors, and now we are offering new ways for investors to pair performance with purpose.

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog.

[1] Net expense ratio shown reflects contractual fee waiver in place 6/30/24. Gross expense ratio is 0.11%

[2] Sources: MSCI and MSCI ESG Fund Metrics as of 8/31/2018. Fund holdings as of 7/31/2018. The iShares ESG 1-5y USD Corporate Bond ETF (SUSB) (98% of securities covered by MSCI Research) is compared with its parent index, the Bloomberg Barclays US Corporate 1-5 Year Index (98% covered). There may be material differences between the fund’s index and the index shown including without limitation holdings, methodology and performance. The MSCI ESG Quality Score measures the ability of underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors. It is calculated as the weighted average of the underlying holding’s ESG Scores, and provided on a 0-10 scale, with 0 and 10 being the respective lowest and highest possible fund scores. MSCI rates underlying holdings according to their exposure to 37 industry specific ESG risks and their ability to manage those risks relative to peers. These issuer-level ESG ratings correspond to an issuer-level ESG Score. To be included in MSCI ESG Fund Metrics, 65% of the fund’s gross weight must come from securities covered by MSCI ESG Research, the fund’s holdings date must be less than one year old, and the fund must have at least ten securities. Past ESG metrics are not indicative of future results.

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