hero-green-blog In an effort to "reduce, reuse and recycle," I have switched from disposable coffee cups to an amazing stainless-steel tumbler that keeps my drinks hot or cold for hours. Just as importantly, I have finally trained my brain to remember to bring it to work with me. Like cutting down on coffee cup usage, adding sustainable investments to a portfolio takes a bit of preparation. Fortunately, it's almost as easy to put into action.

More than stocks

One way that is growing in popularity is the use exchange traded funds ( ETFs ) that seek to track environmental, social and governance ( ESG ) indexes. ESG data providers collect information on companies and rate them with an ESG score. Index providers use these scores as the basis to determine which securities are included in an index and may apply negative screens to exclude certain sectors such as weapons manufacturers or tobacco companies. While people often associate ESG or sustainable investing with stock funds, a similar approach can be used for bond portfolios, too. As with stocks, bond issuers can be rated on distinct ESG characteristics and in turn, the bonds from these issuers. Indeed, ESG analysis has become increasingly important in credit ratings themselves. As demand has grown, credit ratings agencies have been exploring ways to incorporate ESG analysis in their ratings, and some have already started doing so. [storytout]Read more from Karen . [/storytout] Let's look at two approaches to investing in more sustainable bond issuers: ESG and green bonds.

1. Go broad by applying an ESG lens

ESG analysis is about identifying risks and opportunities that may not be captured in traditional financial analysis. For example:
  • Environmental-focuses on the use of scarce natural resources, energy usage and pollution
  • Social-focuses on how a company treats its workers, data privacy and product safety
  • Governance-focuses on business ethics, board structure, executive compensation and accounting practices
It's important to note that when data providers such as MSCI rate companies, they do so based on ESG characteristics that are most relevant to their industry.  For instance, an issuer's environmental impact would be more important for an oil company, while a bank would be more closely judged on the social impact of its lending practices. The creators of ESG bond indexes take these ratings into consideration to determine whether or not these companies make it into the index and at what weighting. Depending on the construction of the index, other factors are used to seek a certain target, such as a similar risk and return profile as the relevant broad market benchmark. For example, guidelines can be set so that the ESG index adheres to certain sector weightings, credit ratings and duration targets. Screens on a company's business involvements like tobacco and weapons can also be applied, in addition to companies that experience a severe ESG controversy (e.g. a massive oil spill or product recall). A broad ESG approach that seeks a similar risk and return profile as the relevant broad market benchmark allows investors to use these funds as portfolio building blocks-much as they would a traditional bond ETF.

2. Green bonds

Green bonds are an even more targeted approach to investing sustainably and are often known as "impact" investments, since proceeds proactively and directly fund sustainable projects. These bonds-issued by foreign government agencies, supranational issuers or corporations-are used to fund new and existing projects that promote environmental purposes. Think solar panels or clean transportation. While there is no governing body that determines whether an issue is "green," the Green Bond Principles are voluntary process guidelines that encourage transparency and disclosure and promote integrity of the green bond market. It's important for investors to ask how these issues are being evaluated and for reporting that details the impact from the use of the bond's proceeds.  A green bond ETF makes it easy for investors to gain diversified exposures to these projects. [storytout]Read iShares Impact Report . [/storytout]

Funds to consider:

ESG Lens:
  • iShares ESG U.S. Aggregate Bond ETF ( EAGG )-Seeks to track an optimized version of the Bloomberg Barclays U.S. Aggregate Bond Index, which includes corporate bonds, mortgage-backed securities, U.S. Treasuries and other investment grade bonds. (ESG scores are applied only to the corporate bond issuers, as MSCI doesn't rate the U.S. government.)
  • iShares ESG USD Corporate Bond ETF ( SUSC )-Holds corporate bonds with maturities of greater than or equal to one year.
  • iShares ESG 1-5 Year USD Corporate Bond ETF ( SUSB )-Holds corporate bonds with maturities of 1 to 5 years.
Green bonds:
  • iShares Global Green Bond ETF ( BGRN )-Seeks to track the Bloomberg Barclays MSCI Global Green Bond Select (USD Hedged) Index.
Karen Schenone , CFA, is a Fixed Income Product Strategist within BlackRock's Global Fixed Income Group and a regular contributor to The Blog .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.