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Foundations of ESG Investing in Corporate Bonds

Environmental, social, and governance (ESG) investing is a very broad field with many different investment approaches addressing various investment objectives across asset classes. While there are many studies relating to ESG in equities, the risk assessment of ESG considerations within fixed income may be equally if not more important. Bonds have limited upside, but in a negative scenario, investors can potentially lose all their invested capital. At a top level, we can break down ESG investing into three main areas that each has its own investment objective (Exhibit 1): first, ESG incorporation, in which the key objective is to improve the risk-return characteristics of a portfolio; second, values-based investing, in which investors seek to align their portfolio with their norms and beliefs; and third, impact investing, in which investors want to use their capital to trigger change for social or environmental purposes — for example, to accelerate the decarbonization of the economy. In this paper, we focus on the first investment objective — ESG as a means to achieve