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Debt markets already price in ESG risks

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Fixed-income investors have lagged in incorporating ESG factors into their strategies, but BlackRock says they now have more tools — including benchmark indexes — to bring sustainable debt into their portfolios.

“Traditionally ESG has been dominated by equity strategies and equity assets, and most ESG concepts have been deeper developed in the equity space,” said BlackRock’s global head of sustainable investing Brian Deese. “ESG in fixed income is harder — it’s different — but it may be even more valuable to understand ESG in fixed income and this is an allocation we think is going to grow significantly.”

In a new paper on Monday, the $6 trillion asset manager said debt investors now have tools to integrate ESG factors into their strategies, with similar risk and return properties to traditional benchmarks. Areas like emerging market debt that used to lack sustainability information now have more of it, BlackRock said. The entrance of sovereign credits into the green market also creates new opportunities.

Fixed-income investors will also be able to draw on research from the equity side, but with a focus on downside risks, since they mostly focus on ensuring companies can repay what they borrow, BlackRock analysts wrote in the report. Governance, for example, can be a more material factor in the credit markets than environmental or social issues, Deese said.

Already, “the market is actually using proxies for understanding ESG data,” Deese said. “You can actually improve and explain some of the divergence in performance of emerging market sovereign credit by bringing to bear more granular data on ESG.”

That presents an opportunity for fixed-income investors that work harder to incorporate this data. Borrowers with strong ESG performance are likely to be better at managing operational and reputational risks, but ESG debt buyers may also have different return goals than equity investors who focus on the space.

Since high ESG ratings are correlated with high credit quality, fixed-income investors may be more focused on how they are giving up yield if they invest on the same principles, Deese said. Industry-specific approaches will also be important and it is now possible for investors to use these new tools to generate ESG bond portfolios without giving up yield, reducing risk in the process.

Nearly all bested the broader market at roughly a third the price of the average fixed income product.
August 17

Deese expects strong growth in ESG strategies over the next five years. “The ‘why not?’ moment in sustainable investing has arrived in fixed income as well,” wrote the analysts.

Bloomberg News

Bloomberg News