Article
For years, a negative interest rate environment has dominated even the Swiss market. And the challenges facing the market will continue to grow in the future. If the major central banks continue to withdraw support after more than a decade of providing it, this can result in increased volatility on the interest and credit markets.
September 6, 2022
Duration management makes this kind of environment more manageable because it allows investors to react to different market conditions. If an ESG filter¹ is used, risks can be reduced even further. Fueled by the negative interest rate environment, issuers have tended to issue long-term bonds in recent years.
These were subsequently included in bond indices, leading to extended durations2 or elevated interest rate risks. Since its launch at the beginning of 2007, the SBI® AAA-BBB has seen durations rise continuously from 5.6 to 6.8. The index reached its lowest duration of 5.03 in May 2009 and its highest of 7.90 in August 2019.
On June 17, 2022, the Swiss National Bank raised its key rate for the first time in over a decade. Bond indices are reacting much more sensitively to high inflation and rising interest rates due to the lengthening durations seen in recent years.
But the current interest rate environment is not the only challenge investors face. A shift is also underway toward sustainability. For investors, sustainable investing means taking environmental, social, and governance (ESG) factors into account when making investment decisions, and in the process identifying new opportunities and new risks3. This paves the way to better risk-adjusted returns4 in the long run.
Since the beginning of last year, SIX has been offering indices that take into account the sustainability criteria listed below for the Swiss equity market (see text box: The SIX ESG methodology) and are very widely accepted on the Swiss market.
Credit Suisse Index Solutions is one of the largest providers of index funds on bonds in Switzerland. Approximately CHF 9.5 bnare invested in the largest index fund on the SBI® AAA-BBB (as of May 31, 2022). Last year saw the launch of the first fund on an SBI® ESG AAA-BBB index with CSIF (CH) Bond Switzerland AAA-BBB ESG Blue. Since the fund was launched, its assets have already grown to over CHF 1.8 bn (as of May 31, 2022).
At the end of May 2022, the CSIF (CH) Bond Switzerland AAABBB 1–5 ESG Blue was added to the sustainable bond fund offering. The fund replicates the SBI® ESG AAA-BBB 1–5 Index and has a shorter duration than CSIF (CH) Bond Switzerland AAA-BBB ESG Blue. In an environment of rising interest rates and high inflation, this can be extremely advantageous since yields on bond portfolios are less sensitive to interest rate hikes.
Composition of the index The Swiss Bond Index (SBI®) has been published since 2007 and is the most frequently used reference index for the Swiss bond market. The SBI® ESG AAA-BBB provides valuable macroeconomic insights into the Swiss capital market. It supplies information on the current price level and expected future yields. The index also sheds light on borrowers’ origins and creditworthiness as well as on the average residual maturity of stock-exchange-listed bonds. It thus forms a suitable basis for the SBI® ESG indices.
The SBI® AAA-BBB ESG is one of the most important benchmarks for the Swiss bond market that incorporates ESG criteria. The SBI® ESG AAA-BBB 1–5 is a great choice for investors who are seeking a broad benchmark with a shorter duration. It replicates the price trend of bonds denominated in Swiss francs with a minimum rating of BBB and a residual maturity of one to five years that are listed on the SIX Swiss Exchange. However, additional ESG criteria are taken into account compared with the underlying index, the SBI® AAABBB 1–5.
Applying the three-stage ESG selection process of the SBI® ESG AAA-BBB results in 75 issuers being excluded out of a total of 356 (21%)5.
61 issuers are disqualified from the index based on their poor ESG rating, and an additional four issuers due to the revenue they earn in critical sectors6. The remaining ten issuers are excluded due to a lack of data. This leaves 281 issuers. Norm-based screening does not result in any exclusions because no issuer is included on the SVVK exclusion list.
The similar composition of the two indices (see Table 1) means that the durations of the two funds are almost identical. Investors who opt for ESG therefore do not have to accept either a lower rating or a markedly lower yield to maturity.
| SBI® AAA-BBB | SBI® ESG AAA-BBB | SBI® AAA-BBB 1–5 | SBI® ESG AAA-BBB 1–5 | |
|---|---|---|---|---|
| Number of stocks | 1,580 | 1,386 | 726 | 598 |
| ESG rating | B (8.13) | B (8.46) | B (7.63) | B (8.13) |
| Duration | 6.99 | 7.27 | 2.83 | 2.87 |
| Yield to maturity | 1.30% | 1.29% | 0.95% | 0.92% |
| Average credit rating | AA | AA | AA | AA |
Source: SIX. Data as of May 31, 2022. The shown yield-to-maturity is calculated as of May 31, 2022 and does not take into account costs, changes in the portfolio, market fluctuations and potential defaults. The yield to maturity is an indication only and is subject to change.
The SBI® ESG AAA-BBB has a diversified sector distribution, whereby the proportion of corporate bonds is slightly lower than for the non-ESG version at 25% versus 28% (see Figure 2). The proportion of government bonds and government-related bonds is, however, slightly higher at 39% (compared with 37% for SBI® AAA-BBB).
The picture is similar for the SBI® AAABBB 1–5 and the SBI® ESG AAA-BBB 1–5. Differences are also identifiable between the SBI® AAA-BBB and the SBI® AAA-BBB 1–5. The indices with shorter durations exhibit a lower allocation to government bonds and government-related bonds as well as to collateralized bonds, while corporate bonds are weighted slightly higher.
Most exclusions due to poor ESG ratings occur in the BBB segment (see Figure 3). This leads to a lower weighting of the BBB segment in the SBI® ESG AAA-BBB and SBI® ESG AAA-BBB 1–5 compared with the SBI® AAA-BBB or SBI® AAA-BBB 1–5, respectively.
Differences in sector allocation between the standard index and the subindex with the lower duration thus also affect the ratings distribution. The SBI® AAA-BBB 1–5 and its sustainable counterpart have a lower weighting in the AAA segment and a significantly higher weighting in the BBB segment.
The SBI® ESG AAA-BBB Index exhibits slightly higher volatility compared with the underlying index while achieving a comparable yield. However, there is barely any difference in the yield to maturity between the two indices at 1.30% for the SBI® AAA-BBB and 1.29% for the SBI® ESG AAA-BBB (see Table 2). The ESG index has recorded a low tracking error of 0.2% over the last three years. The exclusions do not result in any significant deviations in the risk/return profile for the SBI® ESG AAA-BBB 1–5 versus the underlying index. The tracking error is likewise low.
| YTD | 3 months | 1 year | 3 years | |
|---|---|---|---|---|
| Yield | ||||
| SBI® AAA-BBB | –8.5% | –5.2% | –8.7% | –3.1% |
| SBI® ESG AAA-BBB | –8.7% | –5.5% | –8.9% | –3.2% |
| SBI® AAA-BBB 1–5 | –3.4% | –2.8% | –3.8% | –1.4% |
| SBI® ESG AAA-BBB 1–5 | –3.3% | –2.7% | –3.7% | –1.4% |
| Volatility | ||||
| SBI® AAA-BBB | 2.8% | 3.8% | 4.4% | 5.0% |
| SBI® ESG AAA-BBB | 2.9% | 4.0% | 4.5% | 5.1% |
| SBI® AAA-BBB 1–5 | 1.3% | 1.5% | 1.7% | 2.2% |
| SBI® ESG AAA-BBB 1–5 | 1.2% | 1.6% | 1.6% | 2.1% |
| Tracking error | ||||
| SBI® ESG AAA-BBB | 0.3% | 0.3% | 0.2% | 0.2% |
| SBI® ESG AAA-BBB 1–5 | 0.3% | 0.1% | 0.2% | 0.2% |
Source: SIX. Data as of May 31, 2022.
An empirical comparison in particular (see Figure 4) shows that the ESG filter does not have a significant impact on the economic characteristics of the index. Since the inception of ESG indices on December 31, 2016, yields have been almost identical to those of standard indices. There are no identifiable material deviations.
In summary, it is evident that both ESG indices are very close to their respective underlying benchmarks. Given the negligible deviations in the weightings of the sectors and the ESG and credit ratings, the key figures are virtually identical and the tracking error is low. Therefore, it is viable to consider the sustainable option.
The demand for ESG solutions on the Swiss market has grown sharply in recent years and the offering is expandingcontinuously. Credit Suisse Asset Management already offers a broad range of ESG products. There are now 32 index funds and ETFs with ESG benchmarks and combined fund assets of CHF 23.6 bn under management (as of June 2022).
Both of the SIX indices presented are replicated by CSIF (CH) Bond Switzerland AAA-BBB ESG Blue or the recently launched CSIF (CH) Bond Switzerland AAA-BBB 1–5 ESG Blue. Combining both funds offers investors the opportunity to incorporate duration management into their portfolio: the duration can be managed to run between 2.87 and 7.27, thereby reducing interest rate risk in the process.
Example (see Figure 5): If an investor is trying to reach a duration of 5, they can do this by investing 48% in CSIF (CH) Bond Switzerland AAA-BBB ESG Blue and 52% in CSIF (CH) Bond Switzerland AAA-BBB 1–5 ESG Blue. Allocation to CSIF (CH) Bond Switzerland AAA-BBB 1–5 ESG Blue would not only reduce the duration but would also translate into a higher weighting of corporate bonds to the detriment of government bonds and government-related bonds.
The upshot is a higher weighting in the BBB segment and a lower weighting in the AAA segment. This can ultimately result in a higher credit risk as well as higher premiums in relation to the assumed risk.
CSIF (CH) Bond Government Emerging Markets USD ESG Blue is poised for launch. Approval from FINMA has already been secured. The index fund will be available to both institutional and private investors and opens the door to investing in sustainable emerging market bonds in US dollars.
| Fund name | Class | Underlying index | Bloomberg Ticker (Index) | Issuing fees in % | Redemption fees in % | ISIN CSIF | Ongoing charges in % |
|---|---|---|---|---|---|---|---|
| CSIF (CH) BondSwitzerland AAA-BBBESG Blue | QB | SBI® ESGAAA-BBB (TR) | SBESGT | 0.35 | 0.00 | CH0597394557 | 0.11 |
| FB | CH0597394565 | 0.18 | |||||
| ZB | CH0597394540 | 0.01 | |||||
| CSIF (CH) BondSwitzerland AAA-BBB 1–5ESG Blue | QA | SBI® ESGAAA-BBB 1–5 (TR) | SESG5T | 0.25 | 0.00 | CH1189247237 | 0.11 |
| QB | CH1181738381 | 0.11 | |||||
| ZB | CH1181738365 | 0.01 |
The investment promoted in this marketing material concerns the acquisition of units or shares in a fund and not of any underlying assets. The underlying assets are owned by the fund only. If the currency of a financial product and/or its costs is different from your reference currency, the return and cost may increase or decrease as a result of currency fluctuations.
The full offering documentation including complete information on risks may be obtained free of charge from a Credit Suisse representative or where available via Fundsearch (credit-suisse.com/fundsearch).
Fábio von Dach started as a portfolio manager within the Index Solutions Fixed Income Team at Credit Suisse Asset Management in 2021. Before moving to Credit Suisse, he worked as a portfolio manager in the area of commodities, equities, and multi-asset for Picard Angst. Prior to this, he worked at UBS Asset Management as a data analyst for the Investment Algorithms & Validation team. During his studies, he gained further professional experience as an audit intern at PwC and as a consultant in the real estate area at KPMG. Fábio von Dach completed his master’s degree in Banking and Finance at the University of Zurich.
1 ESG stands for environmental (E), social (S), and governance (G). For further information about the ESG investment criteria and the sustainability-related aspects of the fund, please read the fund’s legal and regulatory documents (e.g. its prospectus) and visit credit-suisse.com/esg. In addition to sustainability-related aspects, any decision to invest in the fund should take into account all of the fund’s objectives and characteristics as described in its prospectus or the information which is to be disclosed to investors in accordance with applicable regulations.
2 Duration is a measure of the interest rate risk of a bond based on the term, yield, coupon, or conditions governing early redemption. These varying factors are summarized in a figure that measures how sensitive the bond is to potential interest rate changes and how its value may respond.
3 See also credit-suisse.com/am/esg
4 Source: MSCI: ESG and Performance, https://www.msci.com/esg-101-what-is-esg/esg-and-performance
5 Examples of excluded issuers include Shell International, Total Energies, Kernkraftwerk Gösgen, and Zurich Airport
6 For more information please click here.
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