It’s often said that, in any new endeavor, the first step is the hardest. But for investors and financial advisors looking to step onto the path to ESG and impact investing, the first step can be an easy one—if you take the first step with municipal bonds.

Municipal bonds have the potential to be a low-risk, tax efficient asset class that may dampen overall portfolio volatility and provide income. Additionally, many municipal bonds offer favorable ESG and impact investing opportunities.

Asset Class Characteristics

Most sectors of the municipal bond market, including tax-backed general obligation (states, cities, and counties) and various revenue-backed sectors (utilities, hospitals, etc.), can line up with ESG and values-based investment approaches. Sectors such as education, healthcare, housing, and utilities offer the potential for positive impact through direct investments in communities, school systems, renewable energy products, clean water, and scores of other initiatives.

That said, not all municipal bonds are created equal from an ESG and impact perspective. The municipal bond market includes issues that finance projects such as prisons, detainment centers, fossil fuel power generation, hotels, and shopping complexes. Even in sectors where a positive impact is possible, it takes robust data collection and analysis to select bonds that achieve exceptional outcomes for the communities they serve. Evaluating the available opportunities for ESG and impact requires an experienced team. Strong credit analysis can evaluate ESG factors that are material and relevant to the credit profile, but it requires deep experience to determine whether financed projects can have a demonstrable, positive effect on the surrounding community.

Investment Performance

One common question we receive is whether there is a performance tradeoff in ESG and impact investing. Based on our experience, the answer is no, provided the security selection is managed properly. For bond investors, keeping the primary risk factors (interest rate and credit risk) consistent between the ESG/impact and non-impact equivalents, even as some underlying securities differ, can result in comparable performance and volatility metrics.

Market Growth

ESG and impact investing is a growth area, having seen a compound annual growth rate (CAGR) of 13.6% since 1995. As US SIF reported in its 2018 Report on U.S. Sustainable, Responsible, and Impact Investing Trends, "Total U.S. domiciled assets under management using SRI strategies grew from $8.7 trillion at the start of 2016 to $12.0 trillion at the start of 2018, a 38 percent increase. This represents 26 percent—or 1 in 4 dollars—of the total U.S. assets under professional management." Understanding the ESG/impact market trends and skillfully determining client interest in these strategies can help advisors retain and grow their businesses.

Municipal bonds offer financial professionals an easy way to begin the conversation, particularly when there are minimal differences in performance and volatility between the strategies. And for advisors using such strategies from SNW Asset Management, there are no differences in fees between the two options. This makes ESG and impact investment-grade municipal strategies an easy choice for that first step down the ESG and impact investing path.