Sustainability & Credit Spreads: From Leaders to Improvers

Sustainability & Credit Spreads: From Leaders to Improvers

Key Takeaways

  • A combination of sustainable leaders and improvers may provide an attractive risk-reward profile in a sustainability-themed fixed income portfolio.
  • Issuers viewed as leaders in sustainability may provide downside protection during bouts of market volatility.
  • Beyond sustainable leaders, issuers early in their sustainability transition, also known as improvers, may provide higher spreads and upside potential.
  • Based on our analysis of investment grade corporate issuers, sustainable improvers have offered a higher-than-average spread relative to sustainable leaders or influencers over the three-year period, after adjusting for duration and credit quality.

 

Secular sustainability shift

The shift towards a more sustainable global economy continues to accelerate. At Aegon AM, we believe this secular shift will continue to present opportunities for investors. Entire industries and sectors are evolving as consumers and investors alike demand sustainable solutions, and governments around the world enact regulations to drive sustainability. From consumers and governments to businesses and investors, these four factors are creating what we call a sustainability domino effect. This transition toward sustainability includes various megatrends such as climate change awareness, resource efficiency, eco solutions, health and well-being as well as sustainable growth. For investors, this shift presents compelling opportunities to pursue competitive financial results through a sustainability-themed approach.

 

Sustainable leaders and improvers

Within a sustainability-themed portfolio, investing in sustainable leaders may seem to be an obvious choice as the issuers are clearly aligned with sustainable megatrends. We believe there is merit in looking beyond the leaders in sustainability to identify companies that are in the early stages of their transition—or sustainable improvers. By widening the opportunity set beyond the leaders, fixed income investors have additional opportunities to generate competitive long-term excess returns within a sustainability-themed portfolio.

 

We believe investing in a combination of leaders, influencers and improvers may be an effective strategy to optimize the portfolio’s risk-reward profile. This approach is founded on the idea that sustainable leaders may provide more stable return profiles and potential downside protection in volatile markets while sustainable improvers can provide upside potential.

 

Exhibit 1: Aegon AM’s sustainable issuer categories

 

Category Issuer characteristics
Leader Substantial portion of revenues or assets tied to sustainable products or services and/or industry leader in sustainable business practices
Influencer Material portion of revenues or assets aligned with sustainable products or services and/or some sustainable business practices evident
Improver Demonstrates a clear commitment to transition to products/services or assets aligned with sustainable products or services
Neutral Insignificant amount of revenues or assets aligned with sustainable products or services
Detrimental Products and services against sustainable initiatives  

Source: Aegon AM

 

Analyzing sustainability and credit spreads

To evaluate one aspect of our thesis, we conducted research to analyze historical spreads of investment grade corporate issuers across our proprietary sustainable issuer categories. Our analysis aimed to answer one key question: Do companies categorized as sustainable improvers offer higher spreads relative to sustainable leaders?

 

Our analysis suggests that issuers in the early stages of their sustainability transition may offer higher spread potential relative to the sustainable leaders. This analysis indicates that US corporate credit issuers categorized as sustainable improvers have offered a higher spread than average relative to sustainable leaders or influencers during the three-year time period, after adjusting for duration and credit quality. Further, recent experience affirmed that issuers viewed as leaders in sustainability may provide downside protection during bouts of market volatility as observed in March of 2020. As a result, we believe a combination of sustainable leaders and improvers may provide an attractive risk-reward profile in a sustainability-themed fixed income portfolio.

 

Exhibit 2: Sustainable improvers exhibited wider spreads
Historical spread difference for sustainable leaders, influencers and improvers relative to the median market rating spread

2-25-21-Imp-Ex2-01.jpg

Source: Aegon AM. Spread data begins January 1, 2018 through December 31, 2020. Reflects the historical mean spread relative to the median rating spread. Includes US corporate bonds in Aegon AM’s sustainable investment universe as of December 31, 2020 based on the firm’s proprietary sustainability assessment. For illustrative purposes only. Refer to appendix for important information.

 

Read the full research report

Important disclosures

AegonAM_Sustainability_Credit_Spreads_From_Leaders_to_Improvers.pdf

(4.44MB) PDF

James Rich

Senior Portfolio Manager


Sean Fanning, CFA

Senior Quantitative Research Analyst


Tom Zorawski, PhD

Intermediate Quantitative Research Analyst


Max Zhang, FRM

Intermediate Quantitative Risk Analyst


Read next