ESG Screening Has Help Corporate Bond Investors

New research shows that screening for “green” environmental, social and governance (ESG) criteria has led to positive risk-adjusted returns for corporate bonds. High demand among investors for those bonds contributed to the outperformance, raising the question of whether it will be sustained.

The empirical research into the impact of ESG screening on corporate bond portfolios (including the 2020 study, “Primary Corporate Bond Markets and Social Responsibility,“ and the 2021 study, “Does a Company’s Environmental Performance Influence Its Price of Debt Capital? Evidence from the Bond Market”) has found that high ESG scores (signifying a positive profile on ESG issues) have led to lower corporate bond spreads. The research (such as the 2021 study, “Dynamic ESG Equilibrium”) has found the same impact on equities – higher ESG scores led to higher valuations. Thus, a corporation’s focus on sustainable investment principles has led to a lower cost of capital, providing them with a competitive advantage. It also provided them with the incentive to improve their ESG scores.

That’s good news for investors, as it demonstrates that through their focus on sustainable investment principles, they have caused companies to change behavior in a positive manner. In addition, the lower cost of capital provides incentive for firms to “go green” in terms of new products and services. Increased investor demand has led to a dramatic increase in the issuance of “green” bonds, with a total issuance of $706 billion in 2020 and a total of $1.7 trillion outstanding (though still a small fraction of the overall bond market, representing approximately $100 trillion).