What is the ex-ante impact of different sustainable investment approaches on the alpha of a credit portfolio? And what can investors do who want both outperformance and sustainable credit investments? Credit factor investing provides a solution to both questions.
The volume of corporate bond portfolios managed with sustainability criteria like ESG score or carbon footprint has exploded in recent years. The ex-ante alpha impact of these measures is unclear and difficult for a traditional fundamental credit manager to estimate. However, quantitative portfolio approaches provide a way to obtain a reasonable estimate of the alpha impact.
How can a factor lens be used to estimate the impact of sustainability criteria?
A systematic factor approach combines factors such as value, momentum, or carry into a so-called multi-factor signal, which is used as an alpha estimate in the portfolio construction process. There is strong empirical evidence that higher multi-factor exposure in a portfolio leads to higher expected returns. Figure 1 describes this relationship.
The portfolio containing the 20% of bonds with the highest multi-factor exposure, Q5, shows the best average performance. Performance declines with each reduction in multi-factor exposure. Q3, the median quintile, performs in line with the market, while Q2 and Q1 underperform the market.
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