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ESG in fixed income at a turning point, says Amundi

Investors need to consider the integration of environmental, social and governance (ESG) in investments, after research indicated it had created alpha in corporate bond markets, Amundi has argued.

Eric Brard, head of fixed income at Amundi, commented: “ESG is at a turning point in fixed income. The fixed income universe is an appropriate channel to seek impact on corporate firms. The time has come to reconsider ESG in bond picking processes and bond portfolio construction.”

ESG outperforms

The study found that, since 2014, the credit return on a long/short strategy between best-in-class bonds and worst-in-class bonds is positive for euro-denominated investment grade bonds for the ESG global score, but also for its three pillars ‘E’, ‘S’ and ‘G’.

Buying the 20% best ranked bonds and selling the 20% worst ranked bonds, for example, would have generated an annualised performance of 37 basis points (bps) between 2014 and 2019, the research suggested. Another finding, however, was that ESG investing was a source of underperformance from 2010 to 2019 if long/short best-in-class versus worst-in-class strategies and benchmark-controlled optimised portfolios were considered.

Related: Four lessons for applying ESG in fixed income

Amundi also demonstrated the positive impact of ESG on the cost of capital of issuers. After controlling for credit quality, for instance, it estimated the theoretical cost-of-capital difference was equal to 31bps between a worst-in-class and a best in-class corporate in the case of EUR investment grade corporate bonds. In the case of US dollar investment grade corporate bonds, it is lower but remains significant at 15bps.

Regional differences 

But while this seems to indicate currency plays an important role in ESG investing, Amundi suggested regional differences could instead be influential. “In fact, if we consider the long/short strategy between best-in-class and worst-in-class bonds, our study shows Europe had a systematic positive contribution whereas North America had a systematic negative contribution, whatever the currency – euros or dollars,” it concluded.

“Therefore, this transatlantic divide shows that ESG investing is a source of outperformance when it concerns investment grade bonds of European issuers, but a source of underperformance when it concerns investment grade bonds of American issuers.”

Amundi also picked out reasons for the slower integration of ESG in fixed income compared with equities, suggesting credit agencies increasingly announce they already integrate ESG risks as one of their metrics. Another reason was that bond scoring systems were mainly driven by three factors – duration, credit spread and liquidity – which means playing ESG in a fully diversified investment grade bond portfolio leaves little room for taking on idiosyncratic risks.

Results

Among the study’s key takeaways were:

  • The positive relationship between ESG and performance in the 2014/19 period shows ESG is materialising to the point that it has become a factor. Therefore, ESG must be regarded as a key investment decision driver.
  • Some correlation patterns between ESG and credit ratings exist, as ESG criteria are increasingly integrated in credit-rating methodologies and their impact on valuations of fixed income instruments rises.
  • When selecting asset managers, investors more and more scrutinise their capacity to generate financial performance and a positive impact on ESG. Integration of ESG is now a matter of fiduciary duty for both asset managers and investors.

“These results demonstrate the correlation between ESG investing and ESG financing and highlight that, in order to tackle environmental and social issues, ESG is a winning factor for issuers,” Amundi concluded.

Elena Johansson

Senior Reporter

Part of the Bonhill Group.