We also wanted to establish whether there is a relationship between credit rating, which measures the financial strength of a company, and ESG factors.
In grouping the bonds in the Bloomberg Barclays US Corporate investment-grade index into buckets of low, medium and high ESG scores, we found that:
- The average spread of high ESG bonds was 38bp lower than that of the low ESG portfolio for MSCI data and 35bp lower in the case of Sustainalytics.
- In both cases, investing in top-tier ESG bonds comes with roughly a one-notch uptick in credit quality.
From these results, it is clear that investors should be careful when integrating ESG data in portfolio construction to avoid unintentional biases in allocation and risk profile. Just overweighting better ESG companies can easily result in lower yields and consequently lower returns.
Looking at whether ESG scores relate to future changes in credit ratings, we found that bonds with high Governance scores (using MSCI data) experienced fewer downgrades than those with low G scores.
Looking at E, S and G factors individually, the credit rating differential between top and bottom tiers was more pronounced for the Environment pillar and almost absent in Governance. This could mean that issuers with higher credit quality (stronger balance sheets) are better able to comply with environmental constraints than those with lower credit quality.