Blog

INVESTING
July 12, 2019

Doing Well While Doing Good—Can ESG Limit Downside Risk?

By Bonnie M. Wongtrakool

The effect of environmental, social and governance (ESG) factors on investment returns is a perennial, albeit evolving, topic in the investment community. In a survey conducted by Aon1 in 2018, 38% of global institutional investors not using ESG cited uncertainty around ESG performance as a driving concern. Yet over the past 12 months, interest in ESG has markedly accelerated, and it is worth noting that investors are now asking whether ESG can serve as a risk mitigator at this point in the credit cycle.

Numerous studies on equities illustrate how using ESG in portfolio construction can reduce downside risk and volatility. With historical fixed-income ESG data reaching critical mass, evidence is emerging that these benefits apply to bonds as well. ESG bond funds have historically performed in line with or slightly better than non-ESG bond funds during normal conditions, and have outperformed substantially during periods of market stress. More specifically, a high ESG quality corporate bond portfolio would have outperformed a low ESG quality corporate bond portfolio by 3.6% during the 2014-2016 oil and commodities downturn, according to analysis published by Bloomberg in August 2018. Notably, a portfolio comprised of energy issuers with best-in-class environmental practices would have outperformed one comprised of worst-in-class issuers by 6.5%. Studies have similarly found a positive relationship between performance and ESG within the sovereign sector.

In our own experience at Western Asset, using an ESG integration approach has helped us to avoid underperforming issuers. Our research analysts evaluate material environmental, social and governance factors in conjunction with traditional metrics, seeking to identify investment opportunities where market pricing diverges from fundamental value. As part of this comprehensive research process, our analysts also engage with issuer management to more deeply examine areas of interest and concern. Direct conversations with issuers are a particularly powerful tool with respect to assessing governance, which our analysts treat as the “weakest link.” In a number of cases, governance concerns have led our research team to recommend passing on or divesting from deals, under the principle that poor governance negates the effect from positive environmental and social factors.

ESG investing is already experiencing robust growth due to regulatory support, institutional commitment, climate concerns and generational trends. Half of the investors surveyed by Aon last year stated they would initiate or increase ESG investing if they saw positive research on this front. Accordingly, we believe risk/return studies will provide an additional tailwind to the ESG market over the coming years.

12018 Global Perspectives on Responsible Investing, Aon: https://retirement-investment-insights.aon.com/i/1077234-global-survey-on-responsible-investing/0?

© Western Asset Management Company, LLC 2019. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorised and regulated by Comissão de Valores Mobiliários and Banco Central do Brasil. Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services Licence 303160. Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services Licence for fund management and regulated by the Monetary Authority of Singapore. Western Asset Management Company Ltd is a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan. Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority (“FCA”). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK and EEA countries as defined by the FCA or MiFID II rules.