How Did Climate Corporate-Bond Indexes Weather Market Volatility?

Blog post
7 min read
Afsaneh Mastouri
August 31, 2022
  • Climate corporate-bond indexes generally underweight higher-emitting companies and sectors — namely, energy, utilities and materials.
  • This difference in sector weights might have contributed to the performance of climate corporate-bond indexes, given recent sharp movements in interest rates and credit spreads.
  • We found that the directional moves in rates and credit spreads were the main drivers in how investment-grade climate indexes performed. Single-issuer and sector exposures were stronger drivers of high-yield climate indexes.
Climate indexes tend to have a lower weighting (relative to their parent indexes) allocated to emission-intensive companies, such as those in the energy, utilities and materials sectors.1 Increased commodity prices, especially oil and gas, and the outperformance of energy and commodity stocks this year, have raised the question of whether underweighting energy, utilities and materials led to underperformance of MSCI's climate corporate-bond indexes since the beginning of 2022, or whether they underperformed at all.
Did climate corporate-bond indexes underperform?
Looking at the performance of climate indexes versus market benchmarks, it is not obvious these indexes underperformed the market. The MSCI USD High Yield Climate Paris Aligned Corporate Bond Index, which had virtually no exposure to the energy sector, underperformed the MSCI USD High Yield (HY) Corporate Bond Index (with a 12% allocation to energy) year to date.2 But the MSCI USD Investment Grade Paris Aligned Corporate Bond Index outperformed the MSCI USD Investment Grade (IG) Corporate Bond Index (7% allocation to energy). Additionally, compared to performance of the corporate-bond indexes (<-10%), the difference in performance of the climate indexes from the parent indexes was small, and on occasion, negligible.
How MSCI climate bond indexes fared vs. parent indexes
Excess returns of MSCI climate corporate-bond indexes versus their corresponding parent indexes from Jan. 1 to July 28, 2022. Note that MSCI's climate corporate-bond indexes have a short history. The MSCI USD and EUR Climate Paris Aligned Corporate Bond Indexes were launched in April 2021, for example.
Did energy, utilities and materials bonds outperform the broad corporate-bond market?
To answer this question, we looked at average accumulated return of corporate bonds in major segments of the investment universe since the beginning of 2022 through the end of July.
Year-to-date accumulated return of market benchmarks and higher-polluting sectors

Sector

Universe defined by*

Market-value sector weights

Credit ranking ** A A B B B C

Credit ranking ** A A B B B C

Credit ranking ** A A B B B C

Credit ranking ** A A B B B C

Credit ranking ** A A B B B C

Credit ranking ** A A B B B C

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

None

None

None

A

A

B

B

B

C

None

None

None

Total market

USED IG Index

100%

-9%

-9%

-11%

None

None

None

Total market

EUR IG Index

100%

-8%

-8%

-10%

None

None

None

Total market

USD HY Index, US issuers

82%

None

None

None

-10%

-10%

-10%

Energy***

USD IG Index

7%

-9%

-10%

-12%

None

None

None

Energy***

EUR IG Index

4%

-12%

-10%

-10%

None

None

None

Energy***

USD HY Index, US issuers

11%

None

None

None

-10%

6%

-5%

Materials

USD IG Index

2%

None

-12%

-16%

None

None

None

Materials

EUR IG Index

4%

None

-10%

-10%

None

None

None

Materials

USD HY Index, US issuers

6%

None

None

None

-9%

-10%

-15%

Utilities

USD IG Index

3%

-14%

-15%

-11%

None

None

None

Utilities

EUR IG Index

7%

-13%

-8%

-12%

None

None

None

Utilities

USD HY Index, US issuers

3%

None

None

None

10%

-10%

None

* For the criteria of each universe, see MSCI Fixed Income Indexes.
** MSCI implied credit rating, calculated using S&P Global and Moody's credit ratings for each bond. Data as of July 28, 2022.
*** Bonds of PBF Holding Co. and PPL Energy Supply were removed from the analysis, as the recent upgrade in their rating was due to idiosyncratic factors.

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

Credit ranking **

A

A

B

B

B

C

It is not clear that energy, utilities and materials bonds consistently outperformed the market so far this year. Perhaps the riskiest segment of USD energy bonds (rated lower B and CCC in the high-yield segment) benefited from the tailwind of high oil prices, as the asset value of issuers in this segment improved — hence their distance to default has marginally improved, but overall, the performance of the energy sector was aligned with the rest of the market. In addition, utility bonds underperformed. Squeezed by rocketing energy prices, utilities may have had limited ability to pass the cost to their customers in the current inflationary environment. This was reflected in utility bonds' poor performance, which reveals the sector's continued vulnerability to energy-price-induced inflation.
What drove performance of climate corporate-bond indexes?
As we saw, the average performance of the energy, utilities and materials sectors was fairly aligned with the rest of the corporate-credit market. Now, we take a deeper look into the characteristics of the climate indexes, comparing them to broader credit markets. In the IG universe, directional moves in rates and credit markets explain the relative performance of the climate indexes versus their corresponding parent indexes.3 For example, both effective duration and duration times spread (DTS) of the MSCI USD IG Climate Paris Aligned Corporate Bond Index was significantly smaller than those of their corresponding markets.4 Given the sharp sell-off in bonds due to rising rates and correlated widening of spreads across the universe, this has led to directional outperformance of the MSCI USD IG Climate Paris Aligned Index.
Drivers of performance of climate indexes vs. their corresponding market index
Data for the year to date through July 28. Source: MSCI's BarraOne®
Selecting bonds of issuers with a better emission profile (to achieve decarbonization targets of climate indexes) has had a more pronounced effect on relative performance of HY climate indexes. Differences in sector weightings from the parent indexes explain the underperformance of the MSCI USD HY Climate Paris Aligned Corporate Bond Indexes. Despite lower vulnerability of the MSCI EUR HY Climate Change Index to the credit market sell-off,5 this index only marginally outperformed the corresponding universe, due to its sector and single-issuer deviation vs. the universe.
Drivers of performance of climate indexes vs. their corresponding market index

Contributing factor

USD IG Paris Aligned

EUR IG Paris Aligned

USD HY Paris Change

USD HY Climate Change

EUR HY Climate Change

Total return since beginning of 2022

-11.35%

-8.37%

-11.53%

-11.28%

-10.56%

Accumulated excess return (bp)

57

-10

-52

-26

23

Rates

17

-25

-9

-14

-12

Spread

40

10

-35

-7

16

DTS market exposure

45

2

7

11

44

Spread allocation

-2

-1

-43

-18

-9

Spread carry allocation

-5

-7

-3

-9

-22

DTS allocation

3

6

-38

-9

13

Spread selection

-2

9

1

1

-19

Spread carry selection

-2

0

-2

-3

-3

DTS selection

1

9

3

5

-17

Unexplained

0

5

-8

-5

19

Data as of July 28, 2022. Unexplained element of the return is related to optionality embedded in some of the bonds. Source: MSCI's BarraOne®
As we've seen, the difference between sector and asset (single-issuer credit) exposure of the MSCI climate bond indexes and their parent indexes partially explains the performance of these indexes, especially in the HY market in the year to end of July. The sharp directional moves in underlying risk factors, rates and credit spreads have driven the performance of MSCI IG climate bond indexes during this period, however.
Further Reading
Managing Climate-Transition Risk in Credit Portfolios In Transition to a New Economy: Corporate Bonds and Climate-Change Risk Climate Transition and Bonds: Risk or Opportunity? Aligning with the Paris Agreement: An Index Approach
Afsaneh Mastouri
Afsaneh Mastouri
Executive Director, MSCI Research

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1Climate indexes, regardless of the underlying asset classes, are constructed with the awareness about the CO2 emissions of their constituents and with the intention to reduce the total emission of the portfolio.2That is, MSCI USD HY and IG Paris Aligned Indexes have -12% and -7% active exposure to the energy sector vs. the corresponding market benchmarks (MSCI USD HY and IG Indexes), respectively.3It is not surprising to see that the primary effect of a sharp sell-off in both rates and credit is dominant in IG climate indexes as well as their parent indexes. Note that HY assets and their indexes have been generally less sensitive to sell-offs in rates.4Effective duration of the MSCI USD IG Climate Paris Aligned was 7.3 vs. 7.55 years for the parent index, and DTS 9.3 vs. 10.5% times years, as of July 28, 2022.534-basis-point outperformance due to smaller DTS vs. the market.

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