Investments That Sustain ...

Art by Claudi Kessels

Investors in the U.S. are steadily warming to the idea of using environmental, social and governance (ESG) considerations when building out their portfolios.

Research from Morningstar finds most investors, across ages and genders, have clear preferences for ESG-conscious investment products. Morningstar suggests that 72% of the U.S. population expresses at least a moderate interest in sustainable investing. Institutional investors, similarly, have expressed a good measure of their own cautious but significant interest.

Manan Mehta, senior quantitative research analyst for Northern Trust Asset Management, says sustainable investing themes and bond portfolios make for a good pairing because risk management is a key focus for both.

“Bonds help manage risk through lower correlation and volatility, versus equities,” Mehta wrote in “Sustainable Investing in Fixed Income: Avoiding the Pitfalls,” a white paper published recently in collaboration with Brad Camden, the firm’s director of fixed-income strategy. Their observation is that bonds issued by companies with favorable ESG governance ratings tend to trade at tighter credit spreads with longer durations.

“We find that bonds with higher ESG ratings offered downside mitigation during periods of market turbulence, despite their loose relationship to traditional credit ratings,” Camden and Mehta wrote. “This suggests that investing in companies with the highest ESG ratings may offer further downside mitigation above and beyond what their credit ratings would suggest.”

Northern Trust’s take is far from unique. PIMCO, for example, has published a white paper reaching similar conclusions, titled “ESG Investing and Fixed Income: The Next New Normal?”

Gavin Power, PIMCO’s chief of sustainable development and international affairs, says the institutional and retail investing marketplace is witnessing a growing recognition that ESG issues present material credit risk with respect to both corporate and sovereign debt. He adds that PIMCO’s integration of ESG credit analysis across the entire investment universe “reflects the understanding that investors, like any lender, cannot ignore sustainability and governance issues that may affect a borrower’s ability to repay its debt.”