In Depth

Does ESG Matter for Sovereign Debt Investing?

Our studies show that ESG (environmental, social, and governance) factors are important drivers of sovereign credit spreads and that an ESG-based trading strategy should not detract from investment return potential.

Executive Summary

  • Our research shows that environmental, social, and governance (ESG) scores are significant drivers of sovereign credit spreads. Debt issued by countries with high social and governance scores, in particular, tends to have tighter credit spreads.
  • The relationship between ESG scores and credit spreads is particularly strong for emerging market countries, where we find evidence of an additional ESG risk premium relative to developed markets.
  • We find no evidence that investors are penalized for ESG-aware investment strategies in the form of lower returns.
  • Our analysis supports the case for in-depth ESG analysis in the context of an active approach to portfolio management.

For further details on ESG and sustainable investing in fixed income, please visit our ESG Insights page

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The Author

Lupin Rahman

Head of EM Sovereign Credit

Jeremy Rosten

Client Solutions and Analytics

Pierre Monroy

Quantitative Research Analyst

Shuo Huang

Quantitative Research Analyst

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The analysis contained in this paper is based on hypothetical modeling. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program or strategy.

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PIMCO’s credit research analysts assess the Environmental, Social, and Governance (“ESG”) profile of issuers relative to peer issuers with a goal of separating leaders from laggards. Using industry-specific ESG frameworks, analysts review issuers’ ESG performance based on information available in public filings, recent ESG news and controversies, as well as through engagement with company management teams. Analysts assign three separate numerical scores from 1 to 5 (with 5 being the highest) to their environmental, social and governance-based business practices. The score in each category is related to an issuer’s rank relative to industry peers, and the relative weights of the E, S, and G scores in the composite score vary based on industries, as each industry is assigned a different factor weight. For example, the environmental category has the greatest weight for issuers in extractive industries (e.g., oil, gas, and mining), the social category has the greatest weight for pharmaceutical issuers, and the governance category has the greatest weight for financial issuers. Analysts also include a forward-looking ESG trend assessment, which recognizes companies whose ESG performance is significantly improving or deteriorating. These factors are combined to create a proprietary composite ESG score. We use the MSCI and other ratings for reference but make our own assessment based on our own, independent analysis of the industry and relevant ESG factors. PIMCO’s resulting assessments are proprietary and distinct from those provided by ESG rating providers.

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