Some of Europe's strictest ESG funds are snubbing the world's most liquid investment — the $16 trillion U.S. Treasuries market.
A 33 billion-euro ($36 billion) French state pension plan and ESG funds run by the likes of Erste Asset Management, Joh. Berenberg Gossler & Co. and Union Investment all shun Treasuries based on the U.S. government's stance on capital punishment or climate change. The exclusions rank the U.S. alongside arms makers, tobacco producers and distilleries in falling foul of environmental, social and governance standards.
"ESG-dedicated investors would usually avoid or question investments in U.S. Treasuries," said Rupini Deepa Rajagopalan, head of the ESG office at Berenberg, which oversees about 36.7 billion euros. She cited the death penalty, nuclear weapons and the U.S.'s nonparticipation in global environmental accords, such as the Kyoto Protocol.
Boycotting Treasuries highlights a key challenge for ESG managers that often divides the industry — defining what is and isn't a "responsible" investment. It also shows how ESG investors have to balance ethical standards against the need to make money, particularly when avoiding large liquid markets makes it harder to spread risk or to react quickly in a crisis.
"For any global fixed-income fund, excluding all Treasuries is a very big and far reaching decision," said Chris Brils, a portfolio manager at Actiam NV, which has more than $60 billion in assets. "And what if U.S. Treasuries outperform? You'd be giving up a lot of performance for the benefit of better ESG properties."
European ESG investors who shun Treasuries are also giving up an opportunity to capture positive yields on sovereign debt. Ten-year Treasuries yield about 1.7%, compared with minus 0.47% in Germany.
A spokesperson for the U.S. Department of the Treasury declined to comment on ESG investors.
The French Public Service Additional Pension Scheme, known as ERAFP, excludes Treasuries because capital punishment is allowed in some states, according to Alice Blais, a spokeswoman. The fund, which manages pensions for civil servants, does buy U.S. corporate debt.
Union Investment excludes Treasuries from the 48 billion euros of assets that it runs on the strictest ESG criteria. The funds also avoid French OATs, due to the country's atomic policy, and Poland is being monitored because of free speech concerns.
The investor looks at U.S. mortgage bonds as an alternative to Treasuries, according to Henrik Pontzen, head of ESG at Union, which oversees 349 billion euros in total. It can also buy bonds from companies with high ESG ratings, even if the proceeds aren't specifically earmarked for sustainable projects, he said.
European bond buyers, traditionally the heart of ESG investing, may also be more easily able to snub Treasuries than investors elsewhere because they are naturally less disposed to hold U.S. debt. Still, this could change as ESG investing gains pace elsewhere.
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Other ESG funds exclude sovereigns from their ESG criteria. The $126 million Brown Advisory Sustainable Bond Fund invests "at least 80%" of its funds in ESG-compliant debt, and then also holds securities from the U.S. government and international government entities.
"We aim to achieve as close to 100% positive impact in the fund as we can," said Amy Hauter, a portfolio manager at Baltimore-based Brown Advisory. "Since we do not view Treasuries as having a materially positive ESG impact, we invest in these securities minimally and primarily for liquidity and duration management."
Robeco and Hermes Investment Management are among investors that don't explicitly exclude Treasuries from sustainable funds, partly because they are focused on corporate rather than sovereign borrowers. Hermes recently launched a range of funds that aims to change the behavior of high-yield issuers in line with the United Nations' Sustainable Development Goals.
ESG investors are aware that boycotting Treasuries, or other major nations' debt, may not impact state policies. That's because countries can easily sell notes to a host of other investors and because there is no major history of governments responding to bondholders' nonfinancial concerns.
"It is far more difficult to lobby an overseas government on changing policy than an individual company that a fund may be able to meet face-to-face," said Graeme Anderson, who is chairman of TwentyFour Asset Management and is leading the investment firm's ESG efforts. "All investors have different opinions on what ESG means, but you have to be realistic."