Sustainability: the bond that endures
Sustainable investing is going mainstream. Evidence is building that a focus on sustainability-related factors — ranging from carbon efficiency to quality of governance — can help investors build more resilient portfolios.
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Our key findings
Environmental, social and governance (ESG) investing is spreading to all pockets of the fixed income markets. This includes sectors such as emerging market debt, which were until recently lagging in ESG data, tools and insights. We explain how sustainable investing in fixed income requires a differentiated approach. In contrast to equities, bond investors’ main ESG focus is on mitigating downside risk, rather than capturing upside potential. ESG metrics can help identify new risk factors. Yet the diverse spectrum of debt instruments, issuers and maturities calls for targeted analysis in fixed income.
Read more- Environmental, social and governance (ESG) investing is spreading to all pockets of the fixed income markets. This includes sectors such as emerging market debt, which were until recently lagging in ESG data, tools and insights. We explain how sustainable investing in fixed income requires a differentiated approach. In contrast to equities, bond investors’ main ESG focus is on mitigating downside risk, rather than capturing upside potential. ESG metrics can help identify new risk factors. Yet the diverse spectrum of debt instruments, issuers and maturities calls for targeted analysis in fixed income.
- Innovations in ESG fixed income indexing have created sustainable building blocks that can form the core of portfolios. Our research suggests it is feasible to create portfolios that offer a significant uplift in key sustainability metrics — including ESG scores and measures of carbon intensity — while adhering closely to key characteristics of standard bond indexes, such as their duration and yield. The history of these indexes is relatively short. Yet the early evidence suggests they can deliver on their objectives without sacrificing risk-adjusted returns or diversification.
- We introduce a sovereign sustainability gauge. The tool provides a framework for gauging the performance of 60 sovereign issuers on key ESG issues. The goal: to uncover hidden strengths and vulnerabilities of issuers that may not be captured in traditional macro data. The index draws on 39 metrics available from the World Bank's ESG data portal — and includes a proprietary big data component that scrapes thousands of news articles daily to gauge shorter-term sustainability trends.
- Our research suggests the new ESG lens explains a meaningful share of the variation in credit spreads across EM sovereign issuers today. Strong ESG performers tend to carry lower credit spreads — and vice versa. When we integrated the new ESG lens into a sovereign credit pricing model, we found it to be a stronger building block than traditional sovereign credit ratings from international agencies. Our results suggest that markets are already pricing in ESG-related risks. We see the weight of sustainability in our EM credit analysis rising over time as regulatory pressures lead issuers to pay greater attention to sustainability.
- The financial materiality of different ESG pillars varies greatly across sectors. Our first-of-a-kind ESG materiality matrix for global credit reveals some key differences with standard findings. Among them: the E pillar may have a bigger sway on financial institutions than commonly thought — via carbon transition risks embedded in loan books. We find some evidence that overweighting exposures to the most salient sustainability factors by industry can potentially enhance the performance of portfolios relative to standard benchmarks.
- We show how ESG indexes can be used to make a global multi-asset portfolio sustainable. To illustrate, we walk through implementing ESG in a hypothetical global factor strategy. We replaced the fixed income and equity assets in the portfolio with sustainable equivalents. This resulted in a large uplift in key sustainability metrics. These substitutions had little impact on the portfolio’s diversification or risk/return properties, strengthening our conviction that ESG integration is a "why not?" proposition.
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Sustainable building blocks
Sustainable investing is no longer just a niche strategy in fixed income. The bulk of growth in ESG mandates to date has been in equities, as the chart below shows. But this is set to change. New building blocks such as ESG bond indexes make it easier for investors to bring sustainability into their portfolios.
Gathering momentum
Growth in ESG funds under management, 2010-2019
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Sources
BlackRock Investment Institute, with data from IMF, June 2019. Notes: Data are based on IMF staff calculations using Bloomberg Finance data. The year-to-date (YTD) 2019 data are as of June. The chart shows global ESG-mandated funds only.
Meet the authors
Joel Silva
Portfolio manager – North America Core Portfolio Management team in Global Fixed Income
Jessica Huang
Head of Americas and APA Platform Strategy and Innovation – Sustainable Investing
Sovereign sustainability
We introduce an ESG lens for viewing the sustainability of sovereign bond issuers and explore the relationship between ESG performance and sovereign bond spreads. We explored scoring government bond issuers on their sustainability credentials based on 39 indicators available on the World Bank’s ESG data portal, and a proprietary BlackRock text analysis that measures short-term sustainability trends. See the map below.
Around the world in sovereign sustainability
Rankings by quintile in sovereign sustainability gauge, October 2019
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Sources
BlackRock Investment Institute, with data from Bloomberg and World Bank. Notes: The chart shows rankings of the 60 sovereign issuers as of October 2019, based on 39 World Bank ESG indicators and a proprietary BlackRock text analysis that measures short-term sustainability trends. Issuers are bucketed into quintiles. High rankings indicate positive performance on ESG criteria. See page 9 of the report for details on the methodology and underlying components of the index. For illustrative purposes only.
Meet the authors
Michel Aubenas
Head of EM Hard Currency Sovereign Debt and Sovereign ESG
Christian Carrillo
Head of Macro Asia Rates and FX research - Alpha Strategies Investment group
ESG in credit – what’s material?
What are the ESG factors that really move the dial in financial performance? Our research, built on work by organizations such as the Sustainability Accounting Standards Board (SASB) on sustainability topics most relevant across industries, suggests each of the three ESG pillars are of similar levels of importance in both credit and equities markets, as the chart shows. We compare our findings to a “base case” derived from SASB’s findings. A key conclusion: Governance factors may be more important than commonly thought.
What’s material?
Materiality of E, S and G in global credit, 2015-2019
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Sources
BlackRock Investment Institute, with data from MSCI, Sustainalytics and Refinitiv, October 2019. Notes: The chart shows BlackRock’s estimate of the financial materiality (or relative importance, in percentage terms) of E, S and G factors in driving performance in the equities and global credit market over the five-year period through June 2019. We use regression analysis to estimate the relationship between each ESG pillar and monthly excess returns over the period. The “base case” is derived from BlackRock’s numerical interpretation of the Sustainability Accounting Standards Board (SASB)’s “materiality map.” Equities analysis is based on the MSCI World Developed index. Global credit is based on credit spread returns of the Bloomberg Barclays Global Aggregate credit index. For illustrative purposes only.
Meet the authors
Andre Bertolotti
Head of Global Sustainable Research and Data – Sustainable Investing
Building portfolios
We demonstrate how adding fixed income ESG exposures to a diversified multi-asset portfolio can meaningfully increase its sustainability without sacrificing return objectives. In the case of emerging market debt, our research shows new sustainable EMD indexes allow for a dramatic reduction in the carbon emissions embedded in such exposures. See the chart below.
Curbing carbon
Carbon intensity: standard vs. ESG bond indexes, 2019
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Sources
BlackRock Investment Institute, with data from MSCI, October 2019. Notes: The chart shows the carbon intensity (metric tonnes of CO2 emissions divided by total revenues) of standard equity and bond indexes versus their ESG counterparts. Standard indexes are represented by: JP Morgan EMBI Global Diversified Index, Bloomberg Barclays Global HY Index, Bloomberg Barclays U.S. Corporate Index, MSCI Emerging Market Index, MSCI World Index and MSCI USA Small Cap Index. ESG indexes: JP Morgan ESG EMBI Global Diversified Index, Bloomberg Global HY Sustainable SRI, Bloomberg Barclays MSCI US Corporate ESG Focus Index, MSCI Emerging Market ESG Enhanced Focus Index, MSCI World ESG Enhanced Focus Index and MSCI USA Small Cap Extended ESG Focus Index.
Meet the authors
Katharina Schwaiger
Investment researcher - Factor Based Strategies Group
Brian Deese
Global Head of Sustainable Investing Bio
Philipp Hildebrand
BlackRock Vice Chairman
Richard Kushel
Head of Multi-Asset Strategies and Global Fixed Income
Ashley Schulten
Head of Responsible Investing for Global Fixed Income
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