Barbara Valbuzzi, CFA, Head of Market Strategy, IMI CIB Division, Intesa Sanpaolo looks at the questions and answers.
The growing interest in environmental, social and governance (ESG) credentials among institutional investors reflects the view that ESG insights can deliver better performance. Several studies tested the relationship between ESG ratings and value creation. How is ESG data used in trading and investments?
ESG have so far been used mainly in stock selection. The demand from investors led to a surge in equity sustainable funds and ETFs. Based on Morningstar data, these funds captured the bulk of the inflows in Europe in the first half of this year, gathering $60 billion of net new money, showing more resilience than their more conventional counterparts that, instead, recorded net outflows. This can be explained by the longer-term horizon of ESG-focused investors that are slower to pull money from the funds they are invested in.
It is important to note that these funds adopt different strategies. Therefore, the use of ESG data differs depending on whether the fund’s objective is exclusionary screening, reducing climate risks, generating higher investment returns using ESG criteria or seeking measurable impact.
Do ESG ratings offer meaningful insights about future equity performance?
Several studies tested the relationship between ESG ratings and financial performance, expecting a positive correlation based on the assumption that virtuous companies should outperform. However, the timeframe over which the topic has been studied is often too short to provide robustness to the results. In general, the outcome depends on market conditions and, sometimes, issues around the lack of standardised metrics can lead to non-homogeneous results.
Which are the key differences between ESG ratings vs. financial ratings and what does this mean for trading?
ESG measurements are still a work in progress and private ratings and scores providers are competing to deliver standardised measures. According to ESMA, there are currently about 59 ESG rating providers active in the EU. Furthermore, a recent study showed that ESG scores across six of the most prominent ESG ratings providers correlate on average by only 54%, while credit scores of S&P and Moody’s correlated at 99%. To overcome this challenge there are ongoing calls, from major stakeholders, for legislative actions on ESG ratings and assessment tools to ensure their quality and reliability.
Are fixed income investors looking at ESG?
Investors don’t limit themselves to evaluating equities on an ESG basis only. Fixed income represents a fast-growing area of ESG investing. There has been a record 61% surge in the creation of fixed-income ESG indexes last year, according to the Index Industry Association whose members include the major index providers. ESG-focused investors continued to pour money into sustainable fixed income products despite many investors exiting the broader market, discouraged by interest-rate hikes.
We observed a fast growth in sustainable debt markets in the last few years. Is the high investor demand for bonds with a sustainable impact affecting the secondary market pricing?
The issuance in sustainable debt markets has been resilient so far this year, despite tighter financial conditions, as lower ESG issuance has not been driven by a lack of desire to issue but instead by a broader market slowdown.
Global issuance is down by around 20% compared to last year but it has surpassed $400 billion for Green, Social, Sustainability and Sustainability-linked bonds issued by corporates, governments and SSAs in developed market hard currencies. European counterparts represent more than half of this total as the Euro remains the preferred denomination currency.
Thanks to solid investor demand for sustainable, debt issuers generally benefit from lowered borrowing costs at issuance. In the secondary market, several green bonds trade with a ‘greenium’ (or ‘green premium’) that means a positive difference in yield between the green versus the ordinary bonds, with similar maturity.
Does the secondary volume data confirm the trend in primary markets?
In the first half of 2022, European ESG bond average daily trading volumes continued to increase, mirroring the growth in primary market activity. On average, €1-1.5 billion are traded every day in the secondary market, with a spike in volumes to above €2 billion observed by the latest available AFME data in June. Over the same period, the turnover ratio, calculated by dividing the average daily trading volume by the outstanding amount, remained in the 10-20% range.
What does growth in demand for sustainable investments mean for intermediaries?
Since August, MiFID II gathers clients’ sustainability preferences and advisers are asked to identify the sustainable investments that better align with their client’s preferences while, at the same time, meeting their investment goals and risk limitations. This represents another key driver for growth in sustainable products issuance and secondary trading volumes. Market intermediaries and agency brokers are required to develop adequate skills and focused preparation as well as to provide dedicated services.
