08 Jun 2021

Webcast recap: Why switching to ESG corporate bonds is a natural choice

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Marketing document – FOR QUALIFIED INVESTORS ONLY– This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).

On 25 May, Lyxor was delighted to host a webcast on responsible bond investing with experts from Bloomberg. It was a rare chance to hear straight from the experts in both credit markets and ESG, and to ask your questions on this topic. Below are a few edited highlights from the webcast, which you can listen to in full here.

Mahesh Bhimalingam, Chief European Credit Strategist for Bloomberg Intelligence, started by setting the scene, then explained what he sees as the key story for corporate bonds in 2021. In his view, there is plenty of opportunity within the high yield space in 2021.

MB: The key story for credit in 2021 will be – not credit – but rates. The Covid hit last year resulted, perversely, in one of the best years for credit. Despite vast stimulus from central bank buying, rates went down. As a result, we saw exceptional returns from IG [investment grade] and HY [high yield] corporate bonds.

2021 is a recovery year, which means we might see rates go up as inflation expectations rise. The Bund yield has already risen by around 48 basis points.

Remember it’s a recovery year, and HY spreads are typically supported in recovery. Inflation suits HY too, and IG doesn’t have the same cushion in a rising rate environment. Investors don’t have much of a choice – from a valuation and risk perspective, as an investor you really have to look at high yield this year.

Listen to the full webcast to hear the rest of Mahesh’s presentation:

  • ESG index characteristics vs parent
  • How ESG screening affects sector weights
  • Why tracking error differs between IG and HY ESG 

AJ Lindeman, Head of Index and ESG Quantitative Research at Bloomberg, went on to share his insights on the application of ESG to corporate bond indices.

AJL : When we analyse the ESG factor in corporate bonds, our starting point is not that ESG should have a systematic excess return per se. Socially responsible sustainable investors have additional objectives: policies, social norms, values alignment and so on. So, we look at what kind of trade-offs are made to realise these additional objectives.

Where might these trade-offs come from? How do we determine implications of ESG tilting on portfolios?

Generally, market participants tend to prefer portfolio construction methods that are easy to understand. That’s one reason for the popularity of the rules-based approach to ESG, manifested typically with ESG screens and controversial business exclusions.

Yet these screens can change sector weights and risk characteristics in a portfolio – for fixed income investors, credit quality and duration; for equity investors, style factor exposure.

How do we determine the “ESG only” effect? By changing the portfolio construction technique. What if we could implement an ESG tilt without changing other portfolio characteristics – this should isolate the ESG effect in an allocation. This can be achieved with model portfolios that are constructed with more precision than rules-based techniques allow.

Listen to the full webcast to hear the rest of AJ’s presentation:

  • The relative performance of hypothetical ‘ESG Max’ and ‘ESG Min’ portfolios
  • Untangling ESG factors’ correlation to other risk factors
  • ESG’s potential for downside risk protection

Finally, Philippe Baché, Head of Fixed Income at Lyxor ETF, explained the rationale behind ESG credit, and illustrated how similarly ESG credit indices behave to traditional benchmarks from a risk, return and tracking error perspective. In his view, several factors make the switch a natural choice for bond investors.

PB: ESG in the credit market simply means adding non-financial criteria to a standard bond allocation, and doing so has several benefits.

First, it provides a framework to align values, for example by screening out bond issuing companies operating in areas such as tobacco or thermal coal. It also helps investors to align with new regulation, such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) which increases the incentive to integrate ESG. There is growing evidence that ESG criteria can help mitigate drawdowns too, while the risk/return characteristics of ESG and non-ESG indices are closely aligned enough to make the transition simple.

The Bloomberg Barclays MSCI Sustainable SRI indices tracked by Lyxor’s credit ETFs all have an ESG screen. Once the parent index is selected, a liquidity filter is applied that removes smaller bonds. Issuers without an ESG rating are removed, then ESG criteria are applied.

The ESG screen excludes issuers with a MSCI ESG rating below BBB, who are subject to any very severe controversies, and who are involved in certain activities and businesses, such as alcohol, tobacco, gambling, unconventional oil and gas, thermal coal. We believe in this methodology to the extent that every one of our physical credit ETFs follows it. 

Listen to the full webcast to hear the rest of Philippe’s presentation:

  • ESG index characteristics vs parent
  • How ESG screening affects sector weights
  • Why tracking error differs between IG and HY ESG 

Q&A questions

  • What is your 3-4 year view on IG credit?
  • What is the market impact of ESG filters?
  • Can you explain the benefits of excluding low ESG ratings? 

Watch the replay to hear the answers:

The view from Lyxor

The day is coming when a company’s fortunes will depend on the size of its carbon footprint, the global warming scenario it implies and its willingness to address broader societal issues, just as much as ordinary financial metrics. The best investment decisions keep this bigger picture in mind.

Our recent insight piece explains why we believe the long-term future of performance is green and responsible.

Investing in our unique range of ESG bonds could help you secure a brighter financial future for those you advise or those you love.

As always, you can visit our new ESG Hub to learn more about Lyxor’s ESG range.

This article is for informative purposes only, and should not be taken as investment advice. Lyxor ETF does not in any way endorse or promote any companies mentioned in this article. The opinions expressed by Mahesh Bhimalingam and AJ Lindeman are their own, and do not necessarily reflect the views of Lyxor International Asset Management or Societe Generale. Capital at risk. Please read our Risk Warning below.

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