ESG Impact on High-Yield Returns

Abstract

High-yield bond investors who adopt an environmental, social, and governance (ESG) discipline must consider the potential impact on returns. Recently introduced high-yield benchmarks for ESG-conscious portfolios make it possible to quantify these effects. ESG-based high-yield indexes produced higher historical returns than a standard high-index, but those differences are not statistically significant. The apparently superior downside protection provided by ESG-oriented funds in down markets is explained by two major confounding factors: the ESG-based indexes’ underweighting in Energy bonds and lowest-rated issues. High-yield investors cannot reliably cushion their returns during sell-offs by avoiding issuers involved in controversial weapons or with poor scores in other ESG categories. Energy companies with good ESG scores show no tendency to provide or to not provide superior downside protection in a high-yield bear market. The overall evidence to date on relative performance confirms neither a bonus nor a penalty for adhering to ESG principles within a high-yield portfolio. The growth of investing with attention to ESG factors has generated considerable controversy. Both proponents and critics are keen to answer this question: Must ESG-conscious investors sacrifice return for the sake of their principles, or do good ESG corporate citizens achieve higher profits with less risk, and actually outperform standard indexes? The authors address this question by comparing the returns of recently introduced ESG high-yield indexes and a standard index of the asset class.

TOPICS: Fixed income and structured finance, ESG investing, mutual funds/passive investing/indexing, performance measurement

Key Findings

• ▪ Recently introduced high-yield benchmarks for ESG-conscious portfolios make it possible to quantify the performance impact of adopting an ESG discipline.

• ▪ ESG-based high-yield indexes produced higher historical returns than a standard high-yield index, but the differences are not statistically significant.

• ▪ The apparently superior downside protection provided by ESG-oriented funds in down markets is explained by two major confounding factors. ESG-based high-yield indexes are underweighted in energy bonds and lowest-rated issues.