Hermes Investment Management says recent research has identified a clear link between companies with better ESG scores and their ability to benefit from narrower spreads on credit default swaps.
The data comes from the Credit and Responsibility teams at Hermes, which has pursued further research following a study published in 2017, which looked to develop a pricing model to capture the influence of ESG factors on credit spreads. The latest research has included an additional 500 data points, Hermes said.
As a result, the model can further identify mispriced issuers based on ESG characteristics; investors should beware issuers with low credit spreads and poor ESG performance, Hermes added.
Mitch Reznick, CFA, co-head of Credit, Hermes Investment Management, said: “While the industry has spent years of intellectual capital on pricing operating and financial risks – the core credit risks – we were frustrated that there was no equivalent for ESG. As a result we decided to develop in-house research to examine the relationship between ESG factors and credit spreads. The ESG credit curve that we ended up with is an early, pioneering attempt to price ESG risks.”
Michael Viehs, associate director – ESG Integration, Hermes Investment Management, said: “This research reinforces the necessity of integrating ESG factors into investment decision making in fixed income. Our analysis shows that credit ratings are still not fully capturing the ESG risk dimension of an issuer and therefore it helps us identify issuers whose deteriorating ESG practices could lead to underperformance. By replicating and extending our previous research, we found a stronger relationship between CDS spreads and QESG Scores which matches our qualitative assessments.”
To read the full research report click here: Hermes pricing esg risk in credit markets reinforcing our conviction – October 2018