Integrating ESG in your credit portfolio

Sustainable corporate bonds - a key component in many investors’ portfolios

Exchange Traded Fund (ETF) 15 Jun 2022 30 min read

Authors

Davide Guberti Philippe Kybourg

New exposures in the fixed income sustainable space.

As interest rates look poised to rise, many clients look for ways to reduce the interest rate risk of their portfolio to partially offset the negative effect of higher yields on bond prices. To offer a solution that clients could use in such challenging environments, UBS-AM recently launched two ETFs tracking the liquid corporates 1-5 year sustainable segment of the credit market in the US and Euro-Area.

These new exposures complement UBS-AM’s existing investment grade credit ETF offering, and deepens our position in the fixed income sustainable space.

By construction, these new portfolios inherit some of the well-known features of the Bloomberg Liquid Corporates Index methodology as a starting point. This methodology selects constituents based on certain liquidity criteria such as a minimum amount outstanding of the security or time since issuance of less than two years. In addition to these liquidity criteria, the sustainable version of the liquid corporates index also considers certain business-involvement exclusions and ESG-based exclusions, in a multi-step approach. The first values-based exclusions are designed to exclude issuers tied to activities seen as controversial, such as weapons, tobacco and alcohol to name a few. In a second step, as climate change is becoming an ever-increasing concern for investors, the methodology excludes issuers involved in a broad set of activities that are more impactful to the environment including thermal coal mining and unconventional oil & gas). In a third step, only issuers with a minimum MSCI ESG rating of BBB (and above) and an MSCI ESG Controversy Score of 1 (and above) are selected for inclusion in the final index.

Finally, the 1-5 year sustainable ETF adds another filter, that includes only securities with a time to maturity of one to five years, to focus only on the short-maturity subset of the credit market.

Bloomberg MSCI Liquid Corporates Sustainable methodology nature of the exposure.

The below chart illustrates the nature of the exposure of the Liquid Corporates. — Source: Bloomberg, MSCI, UBS Asset Management. For illustration purposes only.

The chart shows how the liquid corporates sustainable universe is derived from a liquid corporates universe where the following filters are applied: “values-based exclusions” (alcohol, tobacco, gambling, adult entertainment, genetically modified organisms nuclear power, civilian firearms, military weapons) and “climate-related business exclusions” (thermal coal mining, thermal coal power, unconventional oil & gas, fossil fuel reserves). As a final step, only issuers with a minimum MSCI ESG rating of BBB (and above) and an MSCI ESG controversy score of 1 (and above) are selected for inclusion in the final index.

In our latest On Track research publication, we describe how our liquid corporates Sustainable value proposition is formed, and we showcase how a well-constructed sustainable approach allows to achieve various ESG improvements while keeping a limited tracking error. Finally, we demonstrate how these results are applicable irrespective of the short-maturity nature of the exposure.