At a time when yields remain hard to come by, high yield bonds are an attractive option for many investors. Yet with environmental, social, and governance (ESG) factors becoming increasingly influential in investment decisions, persistent myths about the asset class continue to give many investors pause - including a view that sustainable investing may not be compatible with non-investment-grade companies, and a perceived trade-off between an ESG focus and returns. Here we take a closer look at ESG and the high yield segment to help separate fact from fiction.
ESG and high yield investing: not mutually exclusive
There's a general perception that lower-rated companies have weaker governance models, and that high yield allocations thus have heavier exposure to environmentally-unfriendly industries and other "bad actors" in terms of ESG factors. Yet despite some challenges, high yield and responsible investing can coexist - and attention to ESG issues through a research-intensive process can help uncover attractive investment opportunities in a responsible manner.
As asset managers and fiduciaries, we believe the best way to address this challenge is through end-to-end integration of ESG considerations into the investment process - from asset selection, to due diligence, to engagement and monitoring. In our active approach, we see value in allocating capital toward companies with strong or improving ESG profiles, selecting the most attractive high-yield issuers on both an ESG and a fundamental basis to tilt the portfolio toward those with solid ESG profiles, while also providing compelling return potential. Consideration of ESG factors can also help better understand investment risk and evaluate whether the market is pricing that risk appropriately.
Does an ESG focus compromise returns? The opposite may be true
Another persistent misconception is that investors must choose between a strong ESG mandate or strong returns. But experience generally does not bear this out. For example, a Bloomberg Barclays study, one of several looking at this issue, found that US high yield bonds with high ESG scores outperformed those that fared more poorly on ESG measures over the study period (2012-2018). Perhaps not surprisingly, the effect of ESG considerations can also vary greatly depending on the industry or sector considered. According to the study, the governance factor appeared most critical in the banking industry, while environmental considerations were most closely associated with bond performance in the energy and transportation sectors.
In uncertain conditions like we're seeing today, we think it pays to look past broad generalizations and take a more nuanced look when considering investing in any asset class. In high yield especially, we believe a careful, company-specific, bottom-up process, bolstered by proactive engagement and monitoring, is critical to ensure that issuers are abiding by solid ESG principles while maintaining attractive return potential. In this way, investors may benefit from the greater risk mitigation that ESG adherence may allow without sacrificing returns on their high yield allocations.
For more insights into misconceptions around the high yield market, see High Yield Investing Myths to Rethink in the Covid Era .
Investing involves risk, including possible loss of principal. For professional investor use only, not for retail distribution. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. For important information on PineBridge, please visit www.pinebridge.com/global-disclosure.
ESG investing yields positive returns in select bond markets, 22 October 2018. Bloomberg Barclays Bond Indices, MSCI ESG Research, and Sustainalytics, Barclays Research.