Morningstar - Q2 2023 - 39

Sage Advisory also rates bond issuers and will
only invest in companies above a certain
proprietary rating, showing they " exhibit strong
intentionality and improving ESG characteristics. "
It also excludes issuers that have ongoing
controversies. One example is Wells Fargo WFC,
which Sage removed from consideration before
Wells' $3.7 billion settlement announcement
for customer abuses, even though the bank issued
a $2 billion sustainability bond in August 2022.
Engagement is also important. Large bond
managers can pressure companies to improve ESG
practices in ways that equity managers can't,
because equity managers often hold such
small percentages of a company and because
use of proceeds is so important.
What's Next?
Increasingly, Liberatore of TIAA-CREF is seeing
" granularity " in the market-new, differentiated
bond issues. " Blue bonds, " for example,
invest in environmentally beneficial marine
projects. Gender-equity securities' proceeds target
women in underserved communities globally.
There are bonds focused on biodiversity, with a
nature-based KPI.
Also, more bond funds focused on impact have
landed. Some invest in mortgage-backed
securities that help banks make capital available
to low- and moderate-income communities
in their service areas. A pathbreaking fund is
CCM Community Impact Bond CRA CRAIX,
launched in 1999 and advised by Community
Capital Management. The advisor's newest fund
is the subadvised Impact Shares Affordable
Housing MBS ETF OWNS, launched in 2021, which
invests in mortgages from some of America's
poorest communities with the intent of building
homeownership and creating equity.
The sustainable municipal-bond market is also a
growth area, thanks in part to the passage of
the Inflation Reduction Act and the Infrastructure
Investment and Jobs Act. One new entry, launched
in 2021, is VanEck HIP Sustainable Muni ETF
SMI, which measures itself against three of
the U.N. Sustainable Development Goals related
to communities, focuses on climate risk and
resilience, and won't invest in a geography unless
Why Ultrashort Bond Funds Aren't
Cash Substitutes
With interest rates now running well above their
2021 lows, investor interest is perking up in the
short end of the yield curve. CDs, money market
funds, and other cashlike assets are finally
generating attractive yields for the first time in
decades. At the same time, however, investors
have sold off ultrashort bond funds, which
focus on investment-grade bonds with shorterterm
durations (typically less than one year).
The category-which raked in more than
$260 billion in cumulative net inflows over the
10-year period ending in 2021-suffered
about $9.2 billion in net outflows during 2022.
These outflows suggest a potential mismatch
between investors' expectations for safety and
the performance they actually received. Ultrashort
bond funds haven't matched the smooth
ride offered by cash assets. This was particularly
true in 2008, when the average ultrashort
bond fund dropped 8.4%. As the housing market
collapsed, securities that were previously
thought of as safe, such as securities backed by
subprime mortgages, floundered.
Although the disastrous results from the financial
crisis haven't been repeated, ultrashort bond
funds again wavered during the pandemic-driven
downturn in early 2020. Most investmentgrade
bond categories posted positive returns
during the market's flight to quality, but the
average ultrashort bond fund lost about 1.8% in
the first quarter, partly because of its holdings
in credit-sensitive securities such as bank loans,
short-term corporates, asset-backed securities,
and nonagency mortgage securities.
As resurgent inflation prompted the Federal
Reserve to hike interest rates during 2022,
ultrashort bond funds were relatively resilient.
They had small losses during the first two
quarters but made back most of their losses by
the end of the year. As rates rose, managers
for ultrashort funds were able to reinvest
proceeds from maturing bonds at higher yields,
offsetting some of their previous losses.
Because of their somewhat spotty history,
ultrashort bond funds aren't the best holding
for short-term cash needs. They're more
appropriate for investors with a time horizon
of at least one to two years. Even then, investors
should proceed cautiously. If a fund offers
a higher-than-average yield, it's likely taking on
more risk to do so-either by dipping into
corporate bonds with middling credit quality or
investing in more credit-sensitive sectors,
such as structured credits. Investors will likely get
a smoother ride in ultrashort bond funds that
avoid esoteric strategies and maintain a sizable
Treasury buffer, such as Baird Ultra Short
Bond BUBSX, Pimco Enhanced Short Maturity
Active ETF MINT, and Pimco Enhanced Short
Maturity Active ESG ETF EMNT, which
all have Morningstar Analyst Ratings of Gold.
Amy C. Arnott, CFA, is a portfolio strategist at Morningstar
Research Services LLC.
it contains opportunity zones to support job
growth for low-income people. The fund currently
yields 3%.
If anything, higher yields are the main reason to
look at sustainable-bond funds today. " You're
looking at opportunities you haven't seen since
the global financial crisis, " Liberatore says.
For the negative art, this is a welcome change. K
Leslie Norton is editorial director for sustainability
at Morningstar.
Rosie Crawford, analyst, credit ratings, for Morningstar
contributed to this story.
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