ESG investing and pricing

MSCI have released a study relating bond pricing to environmental ratings of issuers. It supports the idea that investors pay a premium for investments that have better environmental credentials. The difference is not huge, but is significant given that the return to investment grade bonds are so low in general. (The spread was 12 bps based on the overall environmental and the BBB spread is 111 bps, so you get about 10% extra excess return above government bonds assets from investing in environmental laggards.)

There are two main ways you could interpret this. The first is to say that the market considers all information in determining the price, so bond issuers with better environmental ratings are actually lower risk than other firms with the same credit rating. The other way of looking at it is that an increasing minority of investors are willing to take lower returns to avoid receiving income that has come from companies that are tainted with a poor environmental impact.

Given that there is an increasing number of ESG-focussed funds in the market we’d tend to favour the second argument.

Source: MSCI

Note that ESG ratings are wildly inconsistent between providers. MSCI’s ratings are mostly sector relative, which means that a high rating represents a company that is better on this metric (in MSCI’s assessment) than others in its industry, rather than being better in an absolute sense. So you can have a coal company with a better rating than a software company, for example. That’s a useful framework for a broad study like this, but not normally what investors are thinking of when they are looking for ESG-themed investments.

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