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 moreSustainable 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
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.
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
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.
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
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.
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
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.