A Guide to ESG Strategies for Municipal Bond Investors

01 June 2022
5 min read
A bird's-eye view of a tollbooth shows a scattering of approaching and exiting vehicles across 30 lanes.
Erin Bigley, CFA| Chief Responsibility Officer
Gavin Romm, CFA | Head—Separately Managed Accounts
Larry Bellinger, CFA| Director—Municipal Credit Research
Marc Uy| Portfolio Manager—Municipal Impact

Municipal bond investors increasingly want to apply environmental, social and governance (ESG) considerations to their portfolios. But, given a broad spectrum of approaches, knowing where to start can be challenging.

We’ve identified three key strategies for incorporating ESG into muni investing, each with a distinct approach that appeals to different investor objectives. Below, we provide an investor guide to ESG integration, screening and impact investing.

Integration: Measuring ESG Across Muni Portfolios

ESG integration is the process of incorporating ESG factors across a portfolio to gauge its risk and return potential more accurately. It’s a familiar theme in equity and taxable bond portfolios, but still evolving in the muni market, where issuers outnumber US investment-grade corporate issuers by 4 to 1.

Why do it? Because ESG factors can—and often do—directly impact an issuer’s bottom line. In fact, ESG-related breaches can lead to downgrades, lawsuits and looming financial burdens. Conversely, issuers that score high on ESG measures may represent exceptional value, since relative strengths and weaknesses may not be apparent without an ESG lens.

Managers who can discern among ESG laggards and leaders will have a leg up on the muni market, which typically doesn’t yet make such distinctions. That makes ESG integration suitable for all muni investors. From short to long duration, from national to state-specific and from high grade to high yield, every muni strategy can benefit from this additional scrutiny.

To root out potential laggards, managers must ask tough questions. Is that city’s drinking water safe (E)? What’s the town’s high school graduation rate (S)? How intense is local government’s political gridlock (G)? We favor a scoring model, applied consistently across issuers, that rates attributes on a scale of 1 to 10. These metrics boil down to a final ESG score, which helps us discern among undervalued bond issues and potential investments whose outsized ESG risks warrant more yield (Display).

ESG Integration Compares Metrics Across Munis
Each muni issuer is scored on things like air quality and poverty rates, which all feed into a comparable final ESG score.

For illustrative purposes only.
As of March 31, 2022
Source: AllianceBernstein (AB)

Screening: Customizing According to Investor Preferences

Some muni investors may want to apply ESG screening to avoid specific issuers based on personal considerations and values. For instance, some avoid utilities that rely heavily on coal for power generation or healthcare systems with poor reputations; others may prioritize air quality, income equity or women’s empowerment. A muni screening strategy can customize portfolios based on what investors care about most (Display).

Examples of ESG Muni Screening, Which Is More Personalized
Screening out issuers who fall short on what investors care about can build best-of-breed portfolios around their values.

For illustrative purposes only.
As of December 31, 2021
Source: AllianceBernstein (AB)

As with integration, muni ESG screening starts with the broad $4 trillion muni bond universe. But after applying ESG screens, managers can further eliminate lower-scoring issuers within the investor’s selected themes.

Given the muni market’s vastness, this kind of screening isn’t easy. Few managers have made the big technological commitment required to gather the data and to screen portfolios for the client’s desired ESG considerations without degrading other key portfolio factors such as quality and yield (Display). But for a bond manager who is properly equipped, screening and best-of-breed approaches can be another notch in the customization toolbelt.

Measuring ESG Doesn’t Have to Cost You
Average-Weighted YTW (percent)
Portfolios that screen out low-scoring issuers in key themes either have given up very little yield or performed better.

For illustrative purposes only.
YTW: Yield to Worst—a measure of the lowest possible yield for bonds that operate within their contract terms without defaulting. Avg. Weighted YTW are for AA-rated, 5% coupon, non-sinkable, non-insured bonds with 6–10-year option-adjusted durations.
As of January 31, 2022
Source: AllianceBernstein (AB)

Impact: Improving Outcomes for Underserved Communities

Impact investing intentionally supports social and environmental progress by focusing on programs or projects with specific purpose and results in mind. In this vein, muni impact investing can deliver positive improvements to historically underserved communities. That’s why it’s a natural fit for muni investors who want to make a measurable difference in addressing socio-economic inequities.

Muni impact investing can target many important ESG-related goals, ranging from improving water supplies and mass transit to energy efficiency and economic development. The Buffalo Sewer Authority, for example, issued a $50 million bond to fund green infrastructure and reduce untreated wastewater runoff into nearby waterways. Likewise, the City of Oakland’s Bond Measure KK funds targeted investments in roads and other infrastructure in neighborhoods that need it the most, along with affordable housing.

Improved access to education and healthcare are frequent focus areas too. For example, Gallaudet University, the world’s only liberal arts college devoted to deaf, hard-of-hearing and deafblind students, issued a $40 million bond to fund facility improvements to further optimize its educational environment. Not far away, the West Virginia University Health System’s bond will help pay for expanded outreach to the state’s more vulnerable and at-risk residents, like teens addicted to opioids or older adults living in remote mountain and rural areas.

Results are just as important as intentionality. Impact investors must measure how each bond’s proceeds are being used to meet environmental or social goals, many of which often overlap. Outcomes that tell us whether the project is successful are measured differently depending on sector or ESG themes (Display).

Tracking Muni Impact: Success Looks Different Across Focus Areas
Key performance indicators, like hospital admissions, graduation rates, and carbon emissions, help track issuer results.

For illustrative purposes only.
The indicators shown are representative of the type of data we seek in our research process.
As of June 30, 2020
Source: AllianceBernstein (AB)

Choosing a Muni ESG Approach Hinges on Investor Goals

As ESG becomes a bigger part of muni investing, it’s important to discern among the many approaches before jumping in. The muni market is vast, and muni bonds—as well as issuers—offer varying ESG-investment risks and rewards. Muni investors considering how ESG adds value to their portfolios should study all their options across the spectrum to know which strategy best aligns with what they hope to achieve.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.


About the Authors

Erin Bigley is a Senior Vice President, AB’s Chief Responsibility Officer, and a member of the firm’s Operating Committee and Women’s Leadership Council. In this role, she oversees AB’s responsible investing strategy, including integrating material environmental, social and governance considerations throughout the firm’s research, engagement and investment processes. Bigley joined the firm in 1997 and previously served as a portfolio manager and trader for the global and Canadian bond strategies. She spent two years based in London as the global head of Fixed Income Business Development for institutional clients. Bigley served as a fixed-income senior investment strategist for over a decade, and as head of the strategist team from 2018 to 2021. Prior to taking her current role, she served as head of Fixed Income Responsible Investing, overseeing the Fixed Income team’s responsible investing strategy. Bigley holds a BS in civil engineering from Villanova University and an MBA from the Massachusetts Institute of Technology’s Sloan School of Management. She is a CFA charterholder. Location: New York

Gavin Romm is a Senior Vice President and Head of Separately Managed Accounts (SMA). He is responsible for the management and strategic growth of AB’s SMA business across fixed income, equity and multi-asset. This includes the construction and ongoing evolution of AB’s deeply customized, technology-driven SMA investment platform, which delivers bespoke solutions to investors across a variety of commercial channels. Previously, Romm was a senior leader responsible for fixed-income technology and data initiatives, driving innovation through data science, quant and automation to enhance AB’s investment decision-making capabilities. Prior to that, he was a portfolio manager and member of the High Yield and High Income portfolio-management teams. Before joining AB in 2013, Romm was a fixed-income specialist at Bloomberg, where he developed and supported fixed-income cash bond and derivative analysis tools. He holds a BA in economics with a minor in entrepreneurship from Trinity College and is a CFA charterholder. Location: New York

Larry Bellinger is a Senior Vice President and Director for the Municipal Credit Research Group, providing high-yield research on municipal credits, with a focus on senior living and hospitals. He initially joined AB in 2012 as a municipal credit research analyst, focusing on municipal credits in Northeastern states, as well as Florida, Ohio and Wisconsin. Bellinger returned to the firm in 2019. In between, he spent three years as a research analyst with Schroders, covering all regions and all municipal sectors for investment-grade and high-yield credits. Earlier in his career, Bellinger worked at Moody's Investors Service, where he primarily analyzed municipal credits in the Northeast. Prior to that, he was an analyst at insurance-rating agency AM Best Company and a D&O underwriter for financial institutions at insurance company Chubb. Bellinger holds a BS in business administration (international business) from Central Washington University, an MBA from Michigan State University and a JD from Rutgers Law School. He is a CFA charterholder. Location: New York

Marc Uy is Vice President and Portfolio Manager for AB's Municipal Impact products. He joined the firm in 2004. Since 2018, Uy has overseen ESG portfolio strategy and research.

After starting his career in equities, Uy moved to municipal bonds, applying a rigorous process and focused approach to ESG investing. By choosing to invest in communities where there are disparities—in healthcare outcomes, academic achievement—he uses the municipal bond market to change the trajectory.

These strategies are backed by research and align with community goals. “We want to be extremely targeted,” Uy says. “We learn about who they are and what they're trying to accomplish.”