Investing is about more than building wealth these days. Investors are increasingly looking for ways to make a difference with their portfolios.
Seventy-five percent of investors say they’re interested in investing for positive change, according to Morgan Stanley’s Institute for Sustainable Investing and its 2017 Sustainable Signals report. Millennials lead the charge, with 86 percent of younger investors expressing an interest in investing with a conscience.
“In recent years, it’s become more critical for investors to not just attain their financial goals, but to attain those goals in conjunction with their values,” says Victoria Fernandez, managing director of Houston-based Crossmark Global Investments and portfolio manager of the Steward Select Bond Fund ( SEACX). Socially responsible investing allows investors to have portfolios that reflect their values. As individuals become more aware of how they can affect the world around them, “socially responsible investing allows them to make a difference, one investment at a time.”
[See: 7 Socially Responsible ETFs for Investors of All Stripes.]
The Forum for Sustainable and Responsible Investment estimates that $8.72 trillion was invested in socially responsible investments through the end of 2015. There’s no shortage of investment options either. Although socially responsible exchange-traded funds and index funds have become more popular, there’s also a growing market for values-based bond investors.
Socially responsible bond funds and bond ETFs can offer a cost-efficient path to sustainable investing. Matthew Peck, co-owner of SHP Financial in Plymouth, Massachusetts, says there are two additional good reasons to invest in bonds. “The first is to provide a hedge during stock market loss; historically, the bond market has performed well or at least is flat while equity markets have fallen,” Peck says. “Second, bonds provide interest or yield that can be used for income or to purchase more equities during volatile periods.”
Building a portfolio of socially responsible bonds begins with understanding your options.
Bond funds versus bond ETFs. Investing in a socially responsible bond fund isn’t the same as investing in a sustainable ETF with bond holdings. One may be a better fit than the other for your portfolio.
The key difference between the two is structure, Peck says. Traditional mutual funds generally have higher administration costs and rely on active management, while ETFs are more passive and index-based. A passive strategy typically translates to lower costs for investors.
Your investment philosophy also comes into play. Peck suggests asking yourself whether you believe an active manager can consistently beat the market. If you’re only trying to keep pace with the market, a bond index fund may be more appropriate. “Conventional wisdom recommends active management in bond funds while taking a more passive approach with equity funds, but both should always be considered.”
There are other things to factor in, aside from cost and management style, says Lloyd Kurtz, head of social impact investing for Wells Fargo Private Bank in Foster City, California. For example, the quality and duration of the bonds the fund invests in determine the returns, depending on the overall market. The fund manager also influences performance. Finally, and perhaps most importantly, is the strategy of the fund or ETF.
The socially responsible goals the fund supports. “Responsible funds often have different perspectives and approaches,” Kurtz says. “Some focus on traditional ideas of social responsibility, others on sustainability and others on impact.”
Before you invest in a socially responsible bond fund or ETF, you need to be clear on whether it supports your goals for sustainable investment. Green bonds, for example, might make more sense if you’re primarily concerned about supporting environmental causes. Something like the TIAA-CREF Social Choice Bond ( TSBRX), on the other hand, invests based on a broader range of environmental, social and governance issues.
Thomas Hudson, director of investment research at TFC Financial Management in Boston, says it’s important to understand the nuances of how a fund or ETF selects underlying investments. For example, the largest ETF with $20 million in managed assets is Inspire Corporate Bond Impact ( IBD), a faith-based bond ETF that invests in “inspiring companies” based on the Inspire Corporate Bond Index. In that scenario, says Hudson, “focusing on how the index defines inspiring is key to understanding the impact your investment is making.”
[Read: Does Socially Responsible Investing Actually Work?]
Hudson also cautions investors to consider the life cycle of a bond fund or ETF. He points out that Morningstar tracks more than 220 socially responsible stock mutual funds and ETFs, but only 42 socially responsible bond mutual funds and ETFs. Four ETFs have launched in 2017, and all currently have relatively low levels of assets. “While not a red flag, there should be a concern the funds don’t attract enough assets to be sustainable over the long term and could be closed.”
How much to allocate toward these investments. Bonds can provide income, minimize volatility and diversify a portfolio. Where you are in your investing timeline may determine how much of your portfolio should be committed to socially responsible bond strategies.
Thomas Graff, portfolio manager of the Brown Advisory Sustainable Bond Fund ( BASBX), says millennial investors shouldn’t discount sustainable fixed-income investments. “Younger investors are eager to make an attractive return on their investments and do so by investing in a way that positively impacts society,” he says. Fixed income allows investors to see a tangible impact, while also offering lower account minimums, making them more accessible to the younger generation.
Understanding a sustainable bond fund or ETF’s structure and strategy can help you determine your ideal asset allocation. Graff uses environmental, social and governance bond funds, which screen out bad players who don’t meet ESG criteria. Issue-specific funds can expose investors to investments that are too alike, and screening out bad players can result in having little to no exposure to important segments of the bond market, Graff says.
Consider also your investment objectives. For example, if you’re younger you may not be thinking about the need for income in your portfolio yet. You’d likely want to shift more of your portfolio toward sustainable equity investments for growth, then downshift into bonds later. A socially conscious investor with five or 10 years remaining until retirement, however, may already be leaning toward a heavier bond weighting.
[See: 9 Ways to Invest in America With Bond Funds.]
In that case, you’d have to decide how much of your fixed-income assets should be dedicated to responsible strategies. Kurtz says it’s important to maintain the right balance between diversification and socially responsible goals. “There are some sectors of the bond market, such as high yield, where there are few choices for responsible investors,” he says. It may not always be possible to combine full diversification with 100 percent commitment to responsible funds.
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