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Impact Series

ESG:

sustainable investing and bond returns

Sustainable investing represents a growing belief that financial criteria alone are not sufficient to evaluate the investment viability of a company. A firm’s impact on the environment, relations with employees and management quality, for example, are important considerations too. The key to ongoing growth in ESG investing is the performance question. Evidence of a positive impact on financial performance may encourage investors to adopt sustainable investment models.

Sustainable investing represents a growing belief that financial criteria alone are not sufficient to evaluate the investment viability of a company. A firm’s impact on the environment, relations with employees and management quality, for example, are important considerations too. The key to ongoing growth in ESG investing is the performance question. Evidence of a positive impact on financial performance may encourage investors to adopt sustainable investment models.

In order to measure a corporate’s long-term sustainability, a set of Environmental, Social and Governance metrics has emerged to help corporates, asset owners and asset managers make decisions.

What effect does investing based on ESG criteria have on portfolio performance?

For some investors, the knowledge that their funds are being invested to support the values in which they believe is so important that they would accept a lower return on their investments. Many more would sign on if convinced that sustainable investing would not hurt – and could even help improve – portfolio performance.

What is an ESG rating?

The three dimensions covered by ESG provide a set of tangible and objective metrics that corporations can be evaluated against. Those who seek to invest more responsibly rely on ESG scores and ratings in their investment decisions.

E is for Environment

S is for Society

G is for Governance

E

is for Environment

Is a company a polluter and does it make any efforts to remedy its impact on the environment?

S

is for Society

Does a company treat its workers well and play a positive role in its community, for example?

G

is for Governance

How well managed is a company? Does a company have appropriate management incentives and sound processes in place?

What is ESG’s impact on the investing ecosystem?

The investing ecosystem includes many participants: on behalf of asset owners (savers and investors), asset managers buy stocks and bonds issued by corporations. ESG criteria have broadened the way participants in the ecosystem think and behave.

The investing ecosystem includes many participants: on behalf of asset owners (savers and investors), asset managers buy stocks and bonds issued by corporations. ESG criteria have broadened the way participants in the ecosystem think and behave.

Individual asset owners want to make the world a better place by allocating resources to responsible companies while maintaining financial performance.

Asset managers acting on behalf of these investors want to be seen as ESG-compliant in order to attract assets, but also need to deliver financial performance in order to retain those assets.

Corporations develop a responsibility agenda to improve the sustainability of their business and to meet investor demand.

Sustainability
of the investment

Investors seek companies that do business "the right way," with enduring business models and practices.

Sustainability
of the planet

Investors also expect companies to consider the effect of their activities on the environment and on society.

ESG encourages a broader view

Asset owners, asset managers and corporations all have to look beyond their traditional remit.

Source: Barclays Research

Responsible investing has gathered momentum

The number of banks and asset managers to sign the UN’s Principles for Responsible Investing (PRI) has increased nearly tenfold in the past decade.

Number of UN PRI signatories and their total assets under management

  • Assets under management (US $ trillion)
  • Number of signatories

    • Source: UN PRI

    ESG scores measure sustainability

    Companies are evaluated on non-financial criteria.

    High E score

    can indicate that a company is less exposed to significant risk due to environmental issues.

    High S score

    can reflect a better ability to attract and retain skilled workers, to maintain consumer loyalty and avoid product liability issues.

    High G score

    indicates a well-run company with strong governance and high-level risk controls.

    Which one of E, S or G is most important to asset owners and to asset managers?

    Source: Barclays Research. Barclays survey of large fixed income asset managers (2016).

    How does ESG align with returns?

    Does the incorporation of ESG criteria improve the financial performance of an investment portfolio or hurt it? Much evidence has been produced showing ESG investing can have a positive impact on equity investments, but there has been a lack of research into its effect on bond portfolios.

    A study by the Barclays Research team fills this gap.

    Does the incorporation of ESG criteria improve the financial performance of an investment portfolio or hurt it? Much evidence has been produced showing ESG investing can have a positive impact on equity investments, but there has been a lack of research into its effect on bond portfolios.

    A study by the Barclays Research team fills this gap.

    The Barclays Research team studied data on bond portfolios over seven years (taking into consideration two providers of ESG scores – MSCI and Sustainalytics), and found that:

    • Introducing ESG factors into the investment process resulted in a small but steady performance benefit. No evidence of a negative impact was found.
    • The performance advantage of portfolios with an ESG tilt was not caused by high-ESG bonds becoming more expensive than their low-ESG peers as a result of excess demand.
    • Of the three scores – E, S and G – the governance score had the strongest impact on performance. Bonds with a high G score also suffered credit downgrades less often.

    ESG encourages a long-term view, which works well for bonds

    Greater emphasis on ESG factors, which play out over a long horizon, may provide a counterweight to the constant pressure on companies to maximise near-term earnings. This longer-term approach to value creation is well-suited to the investment horizon of many bond investors.

    Effect of ESG on bond performance

    Barclays found that ESG factors produced a small but positive return in corporate bond portfolios, with a high G score especially correlating with better performance. Bond portfolios with strong ESG attributes (measured by either MSCI or Sustainalytics) have outperformed low-ESG portfolios in the past seven years. Irrespective of the ESG data source, Governance has the strongest positive effect on performance while the effect of the Social factor was marginal.

    Barclays found that ESG factors produced a small but positive return in corporate bond portfolios, with a high G score especially correlating with better performance. Bond portfolios with strong ESG attributes (measured by either MSCI or Sustainalytics) have outperformed low-ESG portfolios in the past seven years.

    High-ESG bond portfolios perform better than low-ESG ones

    (return difference in % per year)

    Source: Sustainalytics; Barclays Research
    *Sustainalytics’ Governance pillar measures governance of sustainability issues. The firm has a separate Corporate Governance rating that is not represented in this study.

    MSCI ESG Research; Barclays Research

    Irrespective of the ESG data source, Governance has the strongest positive effect on performance while the effect of the Social factor was marginal.

    A high G score has been correlated with better performance

    Relationship between ESG and credit ratings

    The Barclays research also shows that companies with higher ESG scores often have higher credit ratings (measuring financial health) and lower spreads (yield difference over government bonds). The data shows that investing in top-tier ESG bonds comes with a roughly one-notch uptick in credit quality.

    Higher ESG can mean better credit ratings

    Source: MSCI ESG Research, Barclays Research