Bonds with benefits: Combining sustainability and return potential in corporate bond portfolios

What was your study about, and why did you conduct it?

Desislava: The study looks into the relationship between sustainability and corporate bond performance. Everyone knows that sustainability has become a huge focus for investors, and there’s been a lot of research into the effects of incorporating sustainability considerations on the performance of equity portfolios. But there’s been much less analysis of its impact on corporate bond returns, and our research helps fill that gap. Because Quoniam is a quantitative asset manager, we looked at the impact of various measures of sustainability on factor-based corporate bond portfolios.

Our research is also in response to client demand – many investors are keen to cut the carbon footprint of their corporate bond allocation, for example, or tilt it towards companies contributing positively to the United Nations Sustainable Development Goals (the SDGs). We wanted to help them understand the implications for their portfolio’s performance of doing so.

What universe did you consider and over what time period?

Desislava: We looked at investment grade corporate bonds part of a global corporate bond index. This is the largest part of the corporate bond universe, and one of the most attractive for investors. We also wanted to look at high yield corporate bonds and issues from emerging markets, but these universes are smaller, which makes it harder to perform statistical analysis and draw meaningful conclusions. Another problem is that there isn’t such high-quality sustainability data available for these bonds.

How did you assess the sustainability of corporate bonds?

Desislava: We looked at three measures. First, the carbon footprint of the companies issuing the bonds. Second, the impact – positive or negative – that the companies have on progress towards the SDGs. We sourced carbon footprints and SDG scores from external data providers. Finally, we separate corporate bonds into green and conventional bonds.

We chose these three measures as they are among the most popular criteria used by Article 9 funds. In addition, these measures are highly quantifiable and less complicated than aggregated ESG scores. This was important if the results of our study were to be robust. We didn’t use ESG scores because they vary widely and there is little correlated between different providers.

What were your most important findings?

Jieyan: We found that there was a concave relationship between sustainability and corporate bond performance. By that I mean that if you incorporate a certain level of sustainability in a corporate bond portfolio, it has very little impact on the portfolio’s performance potential. For example, we found that reducing a credit portfolio’s carbon footprint by 50 % or having a weight in green bonds three times as high as the benchmark only has a marginal impact on its performance. Additionally, we find that investors with strong sustainability objectives can allocate small exposures to systematic strategies and outperform the corresponding benchmarks while pursuing the original sustainability target. Furthermore, we do not find statistically significant relationship between the three sustainability measures and subsequent performance.

From a factor perspective, we found that there was essentially zero correlation between the sustainability criteria we analysed and the traditional factors that we use in our corporate bond portfolios, such as value and momentum. This makes it much easier to construct a well-diversified sustainable factor-based portfolio.

What does all this mean for investors?

Desislava: It has implications for two groups of investors. First, investors who are primarily motivated by investment performance can increase the sustainability of their corporate bond portfolio to a certain extent without having any significant negative impact on its performance potential.

Second, investors who care most about sustainability and for whom investment performance is a secondary consideration can tilt their corporate bond portfolios towards factors to increase their return potential without any impact on their sustainability profile.

Do you think your results are likely to hold in the future?

Desislava: I don’t think anything will change for the foreseeable future. The results depend on how sustainable measures are priced, distributed and correlated with credit factors, and these requirements are unlikely to change soon. Our paper provides evidence of a low correlation between sustainable measures and individual credit factors, facilitating their seamless integration. Furthermore, we believe that the distribution of highly skewed sustainability measures, such as carbon footprint, is unlikely to change, as companies need time to adapt their business models. Finally, the pricing of sustainability measures is driven by market supply and demand. For example, the total market value of green bonds has increased exponentially in response to the growing demand.

Is Quoniam integrating the findings of this research in its strategies?

Jieyan: We already include different constraints in terms of sustainability in some of our portfolios.
We also help our clients assess the impact of incorporating sustainability criteria on their portfolios’ performance potential. This enables us to set up customised mandates at the sweet spot between performance and sustainability based on their individual needs and preferences.

Bonds with Benefits: Impact Investing in Corporate Debt is available here