Incorporating environmental, social and corporate governance (ESG) factors improves outcomes for corporate bond investors, according to a report from JP Morgan Asset Management.

The asset manager found that ESG scores could enhance portfolio outcomes via lower drawdowns, reduced portfolio volatility and, in some cases, marginally increased risk-adjusted returns.

Although its study showed that using ESG scores improved gross portfolio returns for all categories of corporate bonds, this only held true for investment grade corporate debt once transaction costs were accounted for.

The study involved back-testing portfolios of investment grade, high yield and emerging market debt, comparing their benchmarks with a portfolio constructed using MSCI ESG scores.

The asset manager also set out to find out whether ESG scores differed from traditional agency credit ratings, and said the study suggested that MSCI scores were “additive” to traditional credit ratings.

“The contingent liabilities related to ESG issues are not necessarily factored into rating agencies’ assigned ratings,” said Lovjit Thukral, vice president for global fixed income, currency and commodities (GFICC) at the asset manager and report co-author with Bhupinder Bahra, co-head of the quantitative research group for GFICC.

According to Thukral and Bahra, the study showed that MSCI’s ‘E’, ‘S’, and ‘G’ scores were generally not related to one another or to credit agency ratings. In the investment grade segment, the governance score was negatively related to credit agency ratings.

Another result of the study was that ESG benchmarks (of issuers covered by MSCI) had an inherent quality bias in terms of the performance metrics.

In 2017, Hermes Investment Management found that there was a significant relationship between companies’ ESG credentials and their credit spreads. It recently turned its attention to ESG risks in sovereign bond markets, as did BlueBay Asset Management.

Rating agencies have moved to more clearly demonstrate how ESG considerations feed into their credit analysis in response to pressure from investors.

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