Practical Applications of The Hunt for Alpha in ESG Fixed Income: Fund Evidence from around the World

Abstract

In <ext-link><bold><italic>The Hunt for Alpha in ESG Fixed Income: Fund Evidence from around the World</italic></bold></ext-link>, from the Fall 2022 issue of <bold><italic>The Journal of Impact and ESG Investing</italic></bold>, authors <bold>Inna Zorina</bold>, of <bold>Vanguard</bold>, and <bold>Lux Corlett-Roy</bold>, formerly of <bold>Vanguard</bold>, find that environmental, social, and governance (ESG) fixed-income funds have not consistently outperformed the bond market, after controlling for well-established fixed-income factors. Recent years have seen a rapid rise in assets under management by investment funds that take into account ESG considerations in asset allocation decisions. It is therefore important to understand whether reallocating assets to ESG funds is likely to create alpha (meaning outperformance of the market average) or otherwise affect portfolio returns. The study finds that ESG fund returns are driven by their exposure to credit default risk and term until bond maturity, just like non-ESG funds. Higher-risk and longer-term funds have higher average returns, while ESG funds with higher expense ratios outperform the market less frequently than those with lower expense ratios. Given the lack of consistent alpha and the fact that bondholders do not have shareholder voting rights like those of stockholders, ESG fixed-income funds may or may not align with the goals of impact-investing clients.