Lower credit risk observed in sectors that are positively aligned with the SDGs

Lower credit risk observed in sectors that are positively aligned with the SDGs

07-11-2019 | Insight
Our analysis of historical performance data confirms what we see in practice. Credit sectors with positive or neutral Sustainable Development Goal (SDG) scores have less downside credit risk than those with negative SDG scores.
  • Guido Moret
    Head of Sustainability Integration Fixed Income

Speed reed

  • We evaluated five-year risk-return and default history of 50 credit sectors
  • Sectors with positive or neutral SDG scores outperformed negative scorers
  • SDG screening in credit portfolios may help reduce downside risks

Identifying the companies of the future

Our view is that incorporating the SDGs in an investment strategy creates awareness of the potential additional sources of risk for the portfolio. Launched in 2015 by the United Nations, the SDGs have become a widely adopted framework for assessing the ESG-related behavior and sustainability characteristics of companies.

Those companies and sectors that offer solutions to help achieve the SDGs may well be the winners of the future – as well as being attractive investment candidates. Conversely, those companies and sectors that do not work towards the SDGs could face severe operational and financial repercussions, including fines, license withdrawals and reputational risk, that ultimately could detract from their investment appeal.

To capture these benefits and to help manage the risks, Robeco uses a proprietary SDG screening methodology based on the RobecoSAM SDG framework, which is the starting point for its credits selection process. It is a three-step methodology that looks at what the company produces, how it does so, and whether it is involved in any controversies. The use of SDG screening for credit issuers results in a set of SDG scores, ranging from -3 (for issuers with a high negative contribution to the SDGs) to +3 (a high positive contribution to the SDGs).

In our SDG credit portfolios we exclude individual issuers with a negative rating and only invest in issuers with a neutral to positive SDG rating. The outcome of our screening process is that 24% of our universe has a negative score, and is thus not eligible for our SDG strategies.

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Matching SDG alignment to financial performance

To test our observation in practice that bonds from companies that contribute positively to the SDGs tend to perform better than bonds from companies that make a negative contribution, we looked at data on 50 credit sectors going back five years.

Using the SDG scores generated by our SDG screening methodology, we mapped sector-wide SDG scores to the Barclays sector indices.

Sectors were then aggregated into three theoretical portfolios: one made up of sectors with positive SDG scores (from +1 to +3), one consisting of sectors with neutral (zero) SDG scores, and one with sectors that have negative SDG scores (-1 to -3).

Who’s positive, then?

Of the 50 sectors analyzed, 10 sectors received a negative SDG score. A further 17 sectors received a positive SDG score. The remaining sectors received a neutral score.

The findings show a striking difference in the performance of the SDG-positive sector relative to the SDG-negative sector.

Superior risk-return ratios, better default performance

The data shows that, over the past five years, sectors with a positive or neutral SDG rating had a superior risk-return relationship compared with sectors with negative SDG scores. In other words, risk was lower without returns being diluted. This finding held for both investment grade and high yield credits. The difference between positive and neutral sectors on the one hand and negative sectors on the other was more pronounced for high yield credits.

Figure 1 | Investment grade credit: risk-return, five-year history

Source: Barclays, and Robeco calculations based on the global IG universe. Data up to August 2019, five-year history. The above chart is for illustrative purposes and does not represent the performance of any specific Robeco investment strategy.

Figure 2 | High yield credit: risk-return, five-year history

Source: Barclays, and Robeco calculations based on the global HY universe. Data up to August 2019, five-year history. The above chart is for illustrative purposes and does not represent the performance of any specific Robeco investment strategy.

The finding of a better risk-return profile for positive and neutral SDG sectors is a result of lower credit risk compared with the sectors with negative SDG scores. And, importantly, this risk reduction is achieved without sacrificing returns.

Lower portfolio risk is also reflected in the relative default performance. Examining data for the past five years shows that, over time, sectors with a positive SDG score have lower default rates than neutral sectors. Furthermore, positive and neutral sectors have lower default rates than sectors with negative SDG scores.

Figure 3 | Rolling 12-month default rates

Source: Barclays, JPMorgan, Bank of America Merrill Lynch and Robeco calculations. Data up to December 2018, five-year history. The above chart is for illustrative purposes and does not represent the performance of any specific Robeco investment strategy.

Building more granularity: we look at the detail and not only the sector

It is important to qualify that the above analysis focuses only on sector performance and not on the performance of individual credits. In our SDG measurement framework, we apply a three-step screening process to arrive at SDG scores for the individual companies. If a sector has a negative SDG rating, we do not avoid the entire sector. Instead, the sector score is the starting point, from where we then look at what the issuing company produces, how it does so, and whether it is involved in any controversies. This process could result in a changed score, based on how well the company is aligned with the SDGs.

Our empirical analysis that maps sector-wide SDG scores to sector performances shows a positive link between healthier portfolio performance and neutral-to-positive scoring on sustainability. As we develop a longer track record in SDG credit strategies, we will have more data points for further analysis of this relationship. In particular, it will be interesting to perform the analysis at company level, especially for those sectors in which there is a wide range of SDG scores for individual issuers. In the meantime, these findings support our commitment to incorporating sustainability criteria in our credit selection process, and our view that doing so helps build robust portfolios that perform well financially.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
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Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

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