20 April 2020

How Quantifying ESG Risks in Developed Markets Fixed Income May Enhance Investor Outcomes

Robert Vanden Assem, CFA

Robert Vanden Assem, CFA

Head of Developed Markets Investment Grade Fixed Income

  • ESG factors can either negatively or positively affect the investment performance of fixed income securities across sectors, issuers, and geographic regions.

  • Our team has developed a proprietary set of KRIs – quantifiable ESG metrics developed specifically with credit analysis in mind – to help quantify the potential effects of financially material sustainability issues in terms of implications for an issuer’s cost of funding.

  • Tailoring a top-down KRI analysis by sector offers a more comprehensive view of both direct and indirect ESG risk exposures in credit portfolios.

  • Our research has found that a focused handful of KRIs can help quantify ESG risk exposures effectively while also capturing greater upside return potential.

  • This allows fixed income investors to align their reference universe with actionable metrics on ESG issues that can be employed as both portfolio risk diversifiers and potential alpha enhancers.

How Quantifying ESG Risks in Developed Markets Fixed Income May Enhance Investor Outcomes

PineBridge Investments has developed a proprietary set of Key Risk Indicators (KRIs) that align the Sustainability Accounting Standards Board’s (SASB) financial materiality guidance with practical applications to help investment-grade developed markets fixed income investors evaluate environmental, social, and governance (ESG) issues in terms of credit quality and duration selection. Our research shows how investors can employ these KRIs in security analysis to search for sustainable assets with favorable risk-reward profiles by prioritizing the effective evaluation of sustainability dimensions at the industry level.

Advancements in sustainable investing

Concerns among fixed income asset owners about how to best integrate ESG considerations into investment evaluation continue to grow. Escalating environmental disasters, community and labor force unrest, growing attention to ethical supply-chain management, and other ESG-related issues have more investors focused on the potential reputational and investment risk of investing in securities from headline-prone sectors of the economy.

On a positive note, the disclosure of corporate sustainability risks has continued to move down the path of standardization. Since 2012, SASB has taken ownership of addressing investors’ need for standardized metrics of ESG reporting by publicly listed companies by providing an evidence-based framework for disclosing industry-specific and financially relevant sustainability metrics.

However, while companies’ sustainability disclosure practices have spurred extensive dialogue among financial market participants, they continue to lack consistency, comparability, and a higher level of industry-specificity. In fact, nearly 86% of S&P 500 companies voluntarily disclose broader nonfinancial measures in their filings, 60% of which lack external assurance, and less than 40% discuss sustainability topics beyond traditional governance measures.1

In addition, traditional reporting frameworks have been largely developed and adopted with an accounting-metrics perspective in mind, rather than explicitly for investment management applications. These challenges can make it difficult to translate SASB reporting guidance into useful investment insights for fixed income credit research and portfolio analysis – both in terms of managing specific ESG risk exposures as well as establishing a set of actionable metrics to help generate consistent, quantifiable alpha.

Based on our extensive research in this area, we have introduced a proprietary set of KRIs that translate reporting standards into quantifiable metrics developed specifically with investment analysis in mind. This framework has been established in adherence to SASB guidance, building on the notable transparency and standardization efforts that continue to gain traction among corporate issuers.

Translating reporting standards into portfolio insights

Unlike other standard-setting organizations, such as the Global Reporting Initiative (GRI) and the International Integrated Reporting Council (IIRC), the work of SASB addresses the subset of sustainability information material to investment outcomes. To be included in a SASB standard, a disclosure topic for an ESG issue must have clear evidence of operational and financial impact. For each industry, SASB considers a comprehensive list of sustainability topics, which is subsequently narrowed down to a smaller subset of material issues that are paired up with reference accounting metrics.2

Sample Sustainability Disclosure Topics for Assessing Material Impact


Source: SASB; iComply, 2017. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

The introduction of standardized sustainability metrics beyond governance factors – on which bondholders have historically placed a premium – enables investors to integrate measurable performance indicators from ESG corporate reporting into the evaluation of public entities and of their outstanding tradeable securities. To date, companies such as Adobe, Delta Air Lines, Estee Lauder, Ford, Gap Inc., General Mills, Intel, Merck, Prudential, Travelers, Visa, and Waste Management, to name just a few, have already begun to reference their use of SASB’s guidance and metrics in their sustainability reports. Over the past three years, among companies that have adopted the SASB standards, roughly 60% are US-domiciled and 40% are foreign-domiciled, which is a testament to the global applicability of the framework.3

These types of measurements form the basis for our KRIs. By narrowing down, refining, and benchmarking the ESG considerations with the greatest financial material impact, our KRI framework provides aggregate views of portfolio exposures to individual ESG risks. Our research also has shown that the most insightful KRIs for a particular ESG issue can often differ depending not only on the reference industry of an issuer, but also on the end-markets the issuer’s business model is targeting. This level of customization allows us to perform a more comprehensive and quantifiable cost-benefit analysis of each issuer based on specific industry and ESG issues – ultimately allowing investors to use these factors as both risk diversifiers and potential alpha enhancers in their portfolios.

KRIs: From Company Reporting to Portfolio Analysis


Source: PineBridge Investments. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

Impact and benefits

Our process offers an effective, repeatable way to aggregate ESG exposures by assigning a targeted set of KRIs at the sector level based on inputs from notable think tanks, international associations, multilateral organizations, and supply chain assessments, among others, and leveraging direct engagement with issuers to fill in the gaps in company-reported data – all while maintaining alignment with SASB guidance on comparability of reference metrics. In 2018 alone we found that direct engagement on financially material sustainability issues was key to closing the reporting gap for approximately one-third of our investable universe. Among its key potential benefits, this framework:

  1. Provides practical ESG portfolio management tools designed by and for investment professionals. Our KRIs have been developed with a specific investment-outcome orientation that aims to help quantify the potential portfolio effects of sustainability issues in terms of cost of capital implications. By thinking of cost of capital first, bond investors are able to:

    • Define measurable sustainability profiles for companies in a much more investor-friendly manner than with the current voluntary reporting.

    • Gauge the historical comparability of ESG-focused capital expenditures and corporate commitments on industry value and supply chains, including direct assessment of compliance programs’ effectiveness.

    • Analyze “what if” scenarios by using industry statistics and relevant performance trends based on individual business dynamics.

    The diagram below shows how this process maps SASB standards that corporate issuers have adopted or are looking to adopt to PineBridge KRIs, using the issue of climate change as an example. By assigning KRIs to the sustainability issues with the most material impact on our investable universe (i.e., investment-grade developed markets fixed income credits), we are able to look beyond the short-term nature of corporate headlines and capture the longer-term trends that are most likely to affect portfolio performance. By directly linking specific portfolio allocation guidelines to the ESG risks that exhibit the highest concentration in terms of market-value exposure, the KRIs help investors focus on diversifying away from near-term volatility associated with those risks and building longer-term resilience. In the case below, for example, evaluating an issuer’s quantifiable Scope 1 emissions in relation to overall industry-specific trends helps provide a clearer analysis of relative climate change risk exposures – and suggests a move away from high-carbon-emitting sector concentrations to favor issuers or sub-sectors with well-defined installed capacity for either cleaner fuels or adoption of green technology.

    Mapping SASB Standards on Climate Change to PineBridge KRIs


    Source: SASB and PineBridge Investments as of 6 March 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

  2. Offers industry specificity, which allows for more comprehensive, measurable investment analysis of direct and indirect sector exposures. A key differentiator in our framework is that it evaluates ESG exposures in the context of evolving industry dynamics. In fact, the trends unveiled by establishing KRIs from a top-down sector level can be further applied across geographies and end markets to generate a transparent review of aggregate sustainability performance at the portfolio level. By focusing on ESG dimensions with material impact on a given sector, we are able to identify direct (active) ESG risk exposures and indirect (passive) exposures by comparing cross-industry trends of KRIs, which may not be uncovered if relying on traditional corporate reporting metrics alone.

    From a forward-looking perspective, assessing indirect risk exposures can help bondholders isolate potentially attractive issuers that are pivoting toward embracing more precise disclosure of ESG-relevant corporate metrics. These types of issuers are likely to enhance a portfolio’s sustainability profile by capturing the potential value of sound ESG practices on projected earnings, operational efficiencies, capital expenditures, and – ultimately – cost of capital.

    Measuring direct and indirect sector exposures will allow investors to quantify a bond portfolio’s carbon footprint, for example. This would entail calculating the percentage of sectors and issuers affected by KRIs related to greenhouse gas (GHG) emissions disclosures – both directly (the high carbon emitters, such as the energy sector) and indirectly (through the environmental impacts of GHG emissions on lower-carbon emitters). Accurately analyzing this information can require different KRIs to assess each industry.

    Our research indicates that more than half of the corporate issuers in the investment-grade developed markets fixed income universe are affected by indirect exposure to environmental issues in terms of their need to pay a price to operate in environmentally sensitive supply chains. Yet, the typical approach of focusing solely on a broad-based metric such as GHG Scope-1 emissions does not fully capture the extent to which sectors and individual issuers might be materially affected by operating in carbon-sensitive processes.

    Consequently, lower aggregate CO2 exposure versus the universe (i.e., focusing predominantly on direct exposure to companies operating in the oil and gas and electric utilities sectors) does not guarantee a more sustainable portfolio profile over time. Additionally, managing the magnitude of the overweight in carbon-prone sectors, such as automotive, airlines, real estate, and banking and insurance, as opposed to applying a blanket exclusion on individual energy issuers (and reducing the opportunity set), is likely to yield a more sustainable portfolio in the long term. It does so by ultimately allowing value capture through investments in companies within “sunset” sectors that are aligning their businesses to succeed through the transition to a low-carbon economy.

    How KRIs Can Differ by Industry: Climate Change Sample of Industry-Level Metrics


    Source: SASB classification and sector KRIs identified by PineBridge Investments as of 6 March 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material. CO2-e: carbon dioxide equivalent. gCO2/km: grams of carbon dioxide per kilometer. GJ: gigajoule. Km/L: kilometers per liter. L/km: liters per kilometer. MMbbls: million barrels. MMscf: million standard cubic feet. Mpg: miles per gallon.

  3. Paints a clearer picture of ESG investment risk trends. This more holistic view also allows a deeper analysis of how ESG risk exposures can evolve and keeps our focus on deriving forward-looking insights. The ESG characteristics of the reference investable universe have changed over the past several years based on our KRI analysis. By monitoring this risk profile, we are able to identify the leading sustainability risks associated with each ESG dimension – which we refer to as core ESG issues – based on the overall issuers affected and a three- to five-year directional trend. By aligning the universe with metrics of sustainability risk and trends identified through our KRI analysis at the industry level, we are able to minimize exposure to core ESG issues associated with higher frequency of incidence and negative financial effects, while at the same time building out risk exposures to sectors, companies, and underlying credit structures that are most likely to benefit bondholders.

    Core ESG Issues and Risk Concentration for the US-Dollar-Denominated Investment-Grade Liquid Universe

    Materiality Assessment

    (Core ESG Issue vs. % of Issuers Affected)


    Evolving ESG Risk Concentration


    Source: SASB Industry Classification, Bloomberg Barclays, and PineBridge Investments as of 31 December 2019. Note: The percentage of issuers affected does not total 100%, as an issuer may be affected by multiple factors. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

  4. Targets an improved risk-reward profile from focused investment analysis. The KRI framework also helps focus the ESG risk evaluation in order to enhance performance potential without requiring unrealistic, resource-intensive commitments. Our research has found that adopting a select, targeted set of KRIs in investment analyses based on the characteristics and trends specific to each industry is likely to capture greater risk-adjusted return upside for a portfolio, while avoiding noise.

    By overlaying the SASB guidance on standards, we tested knowledge of the ESG impact we might expect to see in action across sectors and issuers over a three-year horizon. This analysis suggests that focusing on a carefully defined group of six KRIs:

    • Maximizes the Sharpe ratio generated by the universe, and

    • Enhances alpha by one-quarter of a percentage point over that of the universe before accounting for financially material sustainability risk.

    Interestingly, we also found that a decay effect on risk-adjusted performance took place as more KRIs were introduced, at approximately one-tenth of a percentage point per additional KRI beyond the optimal threshold of six. These insights allow us to point to the factors that are likely to affect the financial performance of corporate debt in developed credit markets – and by extension portfolio allocations – over time. By taking it a step further, we are able to identify, in a highly efficient manner, the issuers that face the greatest sustainability headwinds in their sectors, as well as the ones that have made the most progress relative to their peers and end markets.

    ESG Risk-Reward Is Maximized With Six KRIs

    Annualized 3-Year Sharpe Ratio of US Investment-Grade Liquid Universe


    Source: SASB classification, Bloomberg Barclays, and PineBridge Investments as of 31 December 2018. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

Applying KRIs to optimize portfolio diversification and new issue selection

Building an ESG-compliant portfolio ultimately requires an investor to think of sustainability as an additional lever of risk-adjusted performance that needs to be measured at the aggregate portfolio level to truly understand its value. PineBridge KRIs offer a quantifiable basis to help translate financially material ESG issues into practical investment insights to better support effective decision-making at the individual company and sector levels. Through this type of cost-benefit analysis of individual issuers based on the specific industry and the relevant ESG issue, investors can employ ESG analyses both to diversify risk and potentially enhance alpha in their portfolios.

The level of insight that such metrics afford is likely to increase as reporting requirements and regulatory transparency continue to transition from voluntary to mandatory. Looking ahead, as credit rating agencies globally proceed to enhance their risk evaluation tools to account outright for ESG considerations when assessing issuers’ creditworthiness, we believe these types of ESG investing advancements will play an increasingly important role in fixed income portfolio management – in terms of both credit quality and time horizon considerations. In addition, as financial innovation increasingly yields new issuance of ESG-themed and green-labeled securities, it’s becoming the norm to integrate sustainability dimensions for businesses and broad sectors of the economy through comparable measures of their material impact on financial accountability. For investors, we believe these trends will help ensure the most effective portfolio diversification and new issue selection.


1 Investor Responsibility Research Institute (2018), The State of Sustainability and Integrated Reporting.

2 The SASB Materiality Map highlights which sustainability issues are likely to have a quantifiable material impact on industries and corporations: https://www.sasb.org/materiality/sasb-materiality-map/.

3 SASB Adoption Progress Quarterly Report Q4 2019.


Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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