Sustainability Screens Can Boost Corporate Bond Portfolios

The use of sustainability ratings can improve the risk-return ratio of investments in corporate bonds, according to Oekom Research’s new Corporate Bonds Study.

The financial research firm says its Corporate Bond Study is “the first comprehensive analysis on sustainability and corporate bonds worldwide.” The research effort tells a compelling story about sustainability and performance considerations when investing in corporate bonds, Oekom says. This is important for retirement plan fiduciaries serving Employee Retirement Income Security Act (ERISA) plans—as the law dictates sustainability decisions must come second to performance considerations for investments in defined benefit and defined contribution retirement plans.

Corporate bonds are enjoying increased popularity among various types of investors, including institutions and retirement plans, due in large part to persistent low interest rates on investment-grade government bonds. Lower interest rates result in lower yields from government bond securities, driving investors to corporate bonds. But not all corporate bonds are created equal, Oekom explains, and investors are seeking more effective means of building corporate bond portfolios. Researchers at Oekom suggest those investors who take account of how bond-issuing corporations deal with the industry-specific challenges of sustainable development will have clear advantages in terms of the likelihood of default and the interest return on bonds investments.

For the majority of institutional investors, bonds continue to form the backbone of their capital investments, Oekom says. Corporate bonds, in particular, have gained importance in recent years, both in the U.S. and globally. In Germany, according to the latest surveys by the sustainable investment researcher Forum Nachhaltige Geldanlagen (FNG), 23% of sustainably invested capital is invested in corporate bonds, while in Austria the figure is as high as 50%. Calculations by the industry association Eurosif put the proportion for Europe as a whole at as much as 21.3%, Oekom adds.

Another reason sustainability is an important corporate bond screening criteria is that increasing numbers of companies are issuing bonds as an alternative to obtaining financing through bank loans. As a result the range of bonds available on the market has also risen significantly in recent years, Oekom says. The success of a bond portfolio in this environment is essentially determined by the extent to which the portfolio manager succeeds in avoiding the partial or complete default of individual bonds. For this reason, selecting issuers on the basis of risk is particularly important when it comes to corporate bonds, heightening the importance of sustainability factors.

The role that sustainability ratings can play here, Oekom’s analysis shows, is that better sustainability performance and a better sustainability rating go hand in hand with a higher equity ratio for corporate bonds. The firm has developed a metric—the Oekom “Prime” status—as a basis for assessing sustainability and identifying bond-issuing companies with above-average-equity ratios.  

As the firm explains, the Oekom Prime status is awarded to companies that meet industry-specific sustainability management requirements. The equity ratio can be interpreted as an indication of the ability of companies to meet their obligations arising from the issue of their bonds; in other words, the payment of interest and the repayment of the capital, Oekom says.

The study also examined the question of how far sustainability ratings go towards explaining or even determining the level of interest on corporate bonds. One finding was that companies with an above-average sustainability rating have a lower credit spread and are therefore considered by investors to be less risky. The credit spread here is a markup in terms of yield on the risk-free interest rate, Oekom explains.

The higher investors gauge the risk of a bond, the higher this risk premium, which the issuer has to pay to investors, will be. At the same time, taking sustainability ratings into account means that you can make a significantly better evaluation of whether a credit spread is appropriate from a risk perspective and in this way identify the best corporate bonds from the risk-return point of view, Oekom suggests.

The Oekom Corporate Bonds Study was sponsored by Ampega Investment GmbH and Bankhaus Schelhammer & Schattera KAG, together with other asset managers.