New research indicates enhancing ESG profile of a fixed income portfolio has not led to risk-adjusted performance deterioration

New research from Bayes Business School (formerly Cass), commissioned by Insight Investment – a leading global asset and risk manager – has found that enhancing the environmental, social and governance (ESG) profile of a European fixed income portfolio would not have undermined performance over the last 10 years, with tilts improving performance at the margin and controversial sectors making little impact historically.

The study, by Professor Andrew Clare, Professor of Asset Management, Professor Nick Motson, Professor of Finance, and Professor Aneel Keswani, Professor in Investment Management at Bayes examined the impact that ESG factors have had on the performance of European Corporate bond portfolio compositions between 2012 and the end of 2021.

The research used constituents of the iBoxx EUR Corporates bond index, sourced from IHS Markit, overlaid with corporate ESG data from Refinitiv to identify portfolio compositions throughout the time of study. Three construction methods were used: quintile-ranking components, portfolio tilts and controversial sector exclusions.

Main findings of the study included:

• Higher ESG rankings improved risk-adjusted returns overall across the ten-year period. However, in isolation, each ESG factor performed differently from one another, with top quintile portfolios outperforming bottom ones with environmental scores, while the cumulative sector-adjusted performance for the bottom quintile was higher than for the top quintile. The results using social scores alone were mixed and the results focusing solely on governance were not significant.
• ESG tilts would have historically improved performance at the margin. Underweighting low-ranking ESG securities and overweighting high-ranking ESG securities to improve the overall ESG score did not significantly alter the risk-return characteristics of the portfolio compared to the reference portfolio.
• The exclusion of controversial sectors altogether did not have a noticeable effect on the performance of portfolios. Removing securities from the tobacco, mining, defence, oil and gas sectors still yielded statistically similar results identical to the reference portfolio.
• Enhancing ESG credentials reduced tail-risk of a portfolio. A more ESG-friendly mix of securities was found to offer protection from the threat of extremely negative outcomes.

Overall, the research suggests that investors would not have lost out through integrating ESG considerations into their fixed income investment decisions over the last ten years.

Professor Clare said the research had implications for investors and fund managers looking to incorporate ESG considerations into their portfolios without losing out.

“The rise of environmental, social and governance considerations for investors has picked up pace in recent years, with increasing legislation and stakeholder scrutiny,” he said.

“However, with very little independent research in this area, investors may feel nervous that applying ESG in fixed income will harm performance.

“Our research suggests that this need not be the case, and that more emphasis on ESG would – if anything – have broadly improved their risk-adjusted returns over the last ten years. This should offer major encouragement to investors and investment managers wishing to emphasise strong environmental awareness, a responsibility to employees and a robust governance structure in their investment portfolios.”

Robert Sawbridge, Head of Responsible Investment, Insight Investment, said the research reinforced the importance of understanding the purpose and limitations of ESG data and called for the quality of ESG data to mature at a much faster pace than it has done to date.

“It has long been clear to us that ESG issues can be important drivers of investment value,” he said.

“However, a lack of consistency in the quality and methodologies of data providers, as well as significant ongoing data gaps in fixed income, remains a source of some frustration for us as investors.

“We would like to see more standardisation in the ESG data published by companies which then feeds through to aggregators and ratings providers, particularly on areas most relevant to decision making. Ultimately a greater independent verification of what is published would also help contribute to transparency.

“We are thankful to Bayes Business School, with the support from IHS Markit, for conducting such a detailed study as it provides additional independent, academic support for the consideration of ESG risks in fixed income portfolios and gives investors a better understand of the drivers of performance when implementing ESG strategies.”

‘ESG investing and corporate bond portfolios’ by Professor Andrew Clare, Professor Nick Motson and Professor Aneel Keswani is a working paper available on SSRN.