- Fixed-income investors increasingly want a metric to examine how much the trend toward green investing may have impacted market pricing.
- We developed an intuitive curve-based approach adjusting for credit rating and sector to investigate this impact.
- Focusing on the “E” of ESG, we saw hints of an impact, but the difference in spreads between ESG leaders and laggards was small, and the environmental premium in 2021 was not noticeably different from where it was in 2018.
Institutional investors are increasingly focused on building greener portfolios that have reduced exposure to climate-transition and physical risk.1 How might these changes in investor behavior have affected prices in the corporate-bond market? To help answer this question, we introduce the concept of "green spreads" — a measure of how spreads have varied with the environmental-component scores of ESG ratings, while adjusting for credit ratings and sectors.
The MSCI ESG Rating is a composite of three “pillars,” representing environmental, social and governance scores. These pillars are, in turn, composed of “key issue” scores. For example, the environmental pillar, a measure of firm performance with respect to environmental issues, is broken down into multiple key issues, which range from adverse environmental impact on waterways to ecological impacts on natural environments. Investors may use these scores as filters to build bond portfolios that contain issuers with certain targeted characteristics such as heavy involvement in renewable energy or having a low carbon footprint.
In our analysis, we investigated the environmental pillar and one of its key issues, the carbon-emissions score, which measures an issuer’s risk exposure and management mitigation efforts (not simply current emissions tonnage).2 Our goal was to provide a green-spread framework to understand whether issuers’ performance on such criteria have impacted market prices. For each, the pillar and key-issue score, we calculate spreads at the five-year maturity node of the yield curve for “leader” and “laggard” issuers with BBB credit ratings.3 Within each sector, we aggregated spreads across issuers and calculated the average difference between leaders and laggards.
Persistent Green-Spread Premium for Environmental Leaders
Source: MSCI Credit Curves, MSCI ESG Research LLC
The exhibit above shows a persistent difference in leader/laggard spreads based on both the environmental pillar and carbon-emission scores.4 These positive spreads indicate a small premium for leader bond issuers, meaning that yields on bonds of leaders were lower than those of laggards. As of Sept. 24, 2021, this premium was about 12 basis points (bps) based on environmental-pillar scores and about 5 bps based on carbon-emission scores.
We note that the observed premium between leaders and laggards was not noticeably different during 2021 from how it was during 2018-2019. This finding contrasts with previous MSCI research looking at the impact of climate risk on equity pricing. More specifically, the latter research found a noticeable increase in the equity valuations of more-carbon-efficient companies since 2019, consistent with the view that equity markets are beginning to take more seriously potential consequences on valuations from climate change and anticipated future climate policy.
A Tug of War
Movements in green leader/laggard spreads may also reflect the impact of supply and demand dynamics in the market for fossil fuels. The plunge in the price of oil during the early stages of the COVID-19 crisis coincided with the environmental premium spiking, which fell once oil prices recovered. Environmental laggards on average benefited from increases in the price of oil and suffered with declines. For example, the more than 50% increase in the price of oil through Sept. 24, the last date in our analysis, may have supported current spreads on laggards and offset the potential effects of climate change and more aggressive climate policy.5
This tug of war between energy-price dynamics, climate change and climate policy may be closely followed by market participants. As a new metric for measuring the trend in leader/laggard spreads, green spreads may provide a useful addition to investors’ toolkit.
1Oliver, Joshua. “UK green funds attract record retail inflows.” Financial Times, Nov. 9, 2021.
2Carbon-emissions scores are only available for the following Global Industry Classification Standard (GICS®) sectors: energy, materials, industrials, consumer staples, financials and utilities. GICS is the global industry classification standard jointly developed by MSCI and S&P Global Market Intelligence.
3ESG letter ratings (AAA-AA for leaders, B-CCC for laggards) are not produced for pillars or key-issue scores. We define leaders and laggards as the top and bottom terciles of these scores.
4The shaded areas represent a 95% confidence interval.
5Data on front-month crude-oil futures via Refinitiv.