Investors in ESG Corporate Bonds Face Lower Returns

New research shows that spreads have become smaller for corporate bonds among issuers that focus on environmental, social and governance (ESG) factors. Future returns for those bonds will be reduced, but issuers with good ESG track records will enjoy a lower cost of capital.

Sustainable investing continues to gain in popularity. Economic theory suggests that if a large enough proportion of investors chooses to avoid the stocks and bonds of companies with low (poor) sustainability ratings, their security prices will be depressed. Thus, they would offer higher expected returns (which some investors may view as compensation for the emotional cost of exposure to what they consider offensive companies). The reverse would be true of the securities of companies with high sustainability ratings – their security prices will be elevated, reducing their cost of capital. With this knowledge, investors are positioned to pursue their financial goals in the manner that reflects their values and the costs they are willing to bear to achieve those values.