ESG brings positive but not overwhelming outcome to fixed income investments

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The integration of environmental, social and governance factors to fixed income investments has not been detrimental to performance, research has found.

In fact, enhancing ESG credentials have generally led to a reduction in the tail risk of the portfolio, according to the study, which assessed the implications of applying a range of ESG factors to European corporate bonds over the 10 years to 31 December 2021, using bond data by Refinitiv.

Conducted by Bayes Business School and commissioned by asset manager Insight Investment, the study used three methodologies to examine ESG impact: quintile methodology, tilting and exclusions.

Performance – but not at the cost of diversification
Splitting the bonds in quintiles, the Bayes team found that top 20% bonds with the best aggregate ESG scores outperformed the bottom 20% over the decade studied.

But Andrew Clare, chair in asset management at City, University of London, said a pension fund who would only invest in the top quintile would lose diversification benefits.

Speaking at a webinar organised by the asset manager on Wednesday, he said: “If a manager came to me and said, well, of the European bond universe, I'm only going to buy the top 20% of ESG performance I might be a bit nervous about that because you're going to lose diversification  But I think most investors would be more interested in the tilts away from or to particular ESG characteristics”.

The research team looked at the tilting methodology and found that tilting a portfolio towards higher ESG scores marginally improved performance.

Clare, who is also a pension fund trustee, said: “So what this is saying is, if you don't go the whole hog and just invest in the top 20% of ESG performance, but instead you invest in the broad market but with a tilt towards ESG, it won't make much difference at all to your return over time.”

With this methodology, the tilted portfolio slightly outperforms the reference portfolio, he said. “To me, as a trustee, that's a good result, not an uninteresting result,” Clare added.

For the third methodology, the team looked at portfolios that had excluded controversial sectors – tobacco, mining, defence, and oil and gas producers – and found that excluding these sectors would not have affected historical performance.

“The reason is that these sectors actually make up a relatively small weight of the universe,” Clare explained.

ESG outcome for pensions
Clare said the results were on the whole positive but not overwhelming.

However, he added: “If you are a pension fund trustee as I am, and if you are being asked not just by your membership, but also by regulators to consider these issues to report on them, to demonstrate what you're doing about them... then these results are very positive.”

Asked about a potential price hike for the top quintile of companies if all pension funds would only chase after the top 20% ESG scorers, Clare said a pension fund’s main task was to meet all pension payments in full and on time, “regardless of how popular and important ESG has become”.

As a pension fund trustee, he said he would be engaging with one manager about taking into account ESG considerations, but he highlighted: “We wouldn't be just saying go and buy everything with a high ESG rating now,” for the reason suggested.

“I think you’ll be just chasing your tail in that case. From our perspective, integrate [ESG] where you can and where you can add value; where you can't, don't.”

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