Sustainable Bottom Line: Focused sustainable bond funds gained an average return of 7.2% in 2025, continuing a recovery from the sharp decline experienced in 2022.
Notes of Explanation: Universe of focused sustainable long-term bonds funds include taxable and municipal mutual funds and ETFs as of YE 2025, a total of 228 funds/share classes and ETFs classified into 19 investment categories. Sources: Morningstar, Sustainable Research and Analysis LLC.
Observations:
• Despite various challenges and obstacles, all 19 focused sustainable long-term fixed income fund investment categories, encompassing both taxable and municipal funds, achieved positive average returns in 2025. Based on the performance of 228 focused sustainable bond mutual funds/share classes and ETFs representing more than $54 billion in assets, the average 12-month return, and asset weighted average return for this taxable and municipal bonds segment reached 7.2%, the highest average annual return achieved over the last five years. By way of comparison, conventional funds across the same 19 categories generated an average 12-month return of 7.03% and 6.55% on an average asset-weighted basis. As measured by the Bloomberg US Aggregate Bond Index, the bond market gained 7.3% in 2025.
• The broad fixed income market continued its recovery from the sharp decline experienced in 2022 when inflation and rising interest rates led to a drop of 13.01%, as measured by the Bloomberg US aggregate Bond Index. The five-year return is almost at breakeven at -0.31%.
• Some of the investment categories with higher credit, currency, or structural risk (emerging markets local currency, high yield, nontraditional, bank loans), funds exhibiting some of the highest risks based on standard deviations of monthly returns, produced some of the best returns in 2025.
• At the high end of the return range, Emerging-Markets Local-Currency Bond funds were the standout performers, delivering average returns exceeding 26% (vs. -3.8% last year). These results reflect currency appreciation and declining local interest rates in several emerging markets. However, with assets of only $25 million attributable to one fund, the Templeton Sustainable Emerging Markets Bond Fund with its five share classes, this category remains economically immaterial to the broader sustainable fixed-income universe and represents a niche allocation rather than a core holding.
• Credit-oriented strategies delivered compelling risk-adjusted outcomes. Sustainable High Yield Bond funds produced average returns of 8.4% with yields near 6%, supported by resilient corporate fundamentals and spread tightening. Within this segment, the $114.4 million index tracking Nuveen ESG High Yield Corporate Bond ETF posted the best 12-month return, with a gain of 9.12%. Multisector, securitized, and nontraditional bond strategies clustered in the 5–9% return range, benefiting from flexible mandates that allowed managers to allocate opportunistically across credit, sectors, and geographies.
• By contrast, core and core-plus sustainable bond funds, where 60% of the sustainable segment’s assets reside, delivered more modest returns. Sustainable focused Intermediate Core and Core-Plus Bond funds returned an average of 6.9% and 7.4%, respectively, consistent with their role as portfolio stabilizers. These strategies exhibited mild weakness late in the year as reflected in the very narrow negative one-month average returns (-0.2%) posted by the categories, but full-year performance remained competitive relative to historical norms. Returns covering the two investment categories ranged from a low of 5.82% posted by the RBC Impact Bond Fund A, classified as a Core Bond Fund and 9.22% registered by the Calvert Income Fund I, classified as a Core-Plus Bond fund.
• Municipal sustainable bond funds underperformed taxable categories on a nominal basis. National and state-specific municipal strategies generated average returns between 3.2% at the short-end and 4.3% at the intermediate end of the maturity range, reflecting lower starting yields and less benefit from spread compression. While tax-equivalent returns may still be attractive for high-bracket investors, municipals did not participate meaningfully in the year’s return leadership.
• Finally, floating-rate and very short-duration strategies lagged in total returns despite attractive headline yields. Bank loan funds offered the highest yields (nearly 8%) but delivered total returns averaging only 4.2%, illustrating the opportunity cost of limited duration exposure in a year when bond prices rose.
